Auto Bailouts: Good or Bad Idea?

For the past decade or so, Chrysler and General Motors (GM) have been experiencing increasing difficulties. Their market shares have declined because they did not produce cars that captured the interest of enough consumers. Chrysler's market share, for example, dropped from about 17 percent in 1998 to 8.5 percent in 2009, and its workforce dropped from 17,000 in 2000 to 8,200 in 2009. With the decline in market share came rapidly increasing financial problems, and in April 2009 Chrysler filed for Chapter 11 bankruptcy in the U.S. During the six weeks Chrysler spent in bankruptcy protection, it shut down its production facilities. It reopened its manufacturing plants in Brampton and Windsor in late June 2009. Chrysler is now controlled by Fiat, a company that is more adept at producing technically advanced small cars.

GM filed for bankruptcy in June 2009. Its biggest problem was a $7 billion shortfall in its pension plan. There is only one active GM worker for every six retired workers (at Chrysler, there is one active worker for every two retired workers). After emerging from bankruptcy, GM plans to produce the Volt (a "green" electric car), but doesn't know when it will be profitable.

The U.S. and Canadian governments required GM and Chrysler to come up with a restructuring plan before they would receive any bailout money. In the U.S., GM reached an agreement with the United Auto Workers union on a new contract which reduced its costs, but that put pressure on the Canadian Auto Workers union to also reach a new agreement. If they didn't, GM Canada might cease to exist because the government of Canada wouldn’t give GM the bailout money it needed to survive. The Canadian government said it had no choice but to get involved in a bailout once the U.S. government decided to give money to GM and Chrysler. The U.S. government essentially told Canada that if we didn't help out, GM and Chrysler would leave Canada and all those auto jobs would be lost.

Back in 2008, the federal Ministry of Industry said that the government of Canada would not provide bailouts to auto companies. But in the end, the Canadian government agreed to give GM about $10 billion (the U.S. gave GM about $50 billion. Both governments will now own a percentage of GM (the U.S. will own 72 percent of the company and Canada will own 13 percent). As part of the deal, debt holders will trade $27 billion in debt in return for a 15 percent stake in GM. In return for the bailout money from the Canadian government, GM promised to maintain 16 percent of its North American production in Canada (that’s down from 22 percent before bankruptcy was declared). GM Canada’s workforce will be about 4,400 (it was 20,000 in 2005). The Canadian and U.S. governments also gave bailout money to Chrysler (the U.S. will now own a 20 percent stake in Chrysler and the Canadian government will own 2 percent).

Opponents of Bailouts

Critics of the auto bailouts have several objections. The first, and most fundamental, objection is that government should not prop up businesses that are in trouble. If a company is not doing well, it should be allowed to fail. There is an old saying that goes something like this: "Governments are terrible at picking winners, but losers are great at picking governments." The government seems to have forgotten decades of hard lessons that they should not get involved in market-oriented businesses. But now they are involved in the automobile business, and the government is essentially investing money where private citizens would never be willing to put it. Writing in the National Post on June 4, 2009, Terence Corcoran said that ". . . along with Chrysler, GM is sliding through a government-backed reorganization and emerging as part of the same old whining, subsidy-seeking, protectionist, union-locked North American auto industry." He also noted that most of the $10 billion bailout is not going to rebuild the company, but to pay off GM's pension commitments to its workers. He says that Canadian taxpayers are paying to cover pensions of auto workers that the union "extorted" from the auto companies. He estimates that over the last 20 years, Canadian car buyers have paid $10 billion in higher auto costs to cover union workers' contracts and pension entitlements. Many Canadians don't have much of a retirement fund, and they make a lot less than auto workers do, but they are being asked to help bail out the pensions of auto workers.

Second, the GM bailout will cost Canadian taxpayers about $1.4 million for each job that is "saved." That is a very high price to pay for each job. There is also concern that GM will need more bailout money in the future, and the company is therefore a poor choice for a bailout. What’s worse, bailouts won't save jobs overall. Rather, they will simply destroy jobs at companies like Toyota and Ford, who didn't get bailouts. Ford will now be saddled with more debt than GM or Chrysler, but Ford shouldn't be punished for not needing bailout money in the first place. Mark Milke, director of research at the Frontier Centre for Public Policy, says that the bailouts for GM and Chrysler are nothing more than a transfer of wealth to companies that consumers have already rejected.

Third, the bailouts in the auto industry will likely lead companies in other industries to requests bailouts. For example, the forestry, fisheries, auto parts, and commercial airline industries are all having financial problems. The federal government has already announced $1 billion in aid for the pulp and paper industry so they can invest in technology that will make them more energy efficient and environmentally friendly.

Fourth, there is skepticism that the bailout money will ever be repaid. In 1987, GM's assembly plant in Quebec received $220 million in interest free government loans. But GM pulled out of the province in 2002 and didn't repay any of the money. If the latest bailout money is not repaid, Canadians will have to bear the burden through higher taxes and/or cuts to public services. Critics are asking why the government is sinking money into two companies that have been steadily losing market share. Peter Coleman, president of the National Citizens Coalition, says that the bailout money will be useless if people don't start buying cars made by Chrysler and GM.

Fifth, the usual lender hierarchy is not being observed in the bailout plan. In the U.S., for example, the Indiana State Police Pension Trust was entitled to first priority under U.S. bankruptcy law, but they were "persuaded" to accept only 30 cents on the dollar. The UAW, on the other hand, got 50 cents on the dollar even though they weren't as high on the priority list. When things like this happen, creditors have difficulty pricing the risk of investing because the rules of the game are changed on short notice. In the future, lenders will be more fearful that the government will intervene and not give them what they are due if a bankruptcy occurs.

Supporters of Bailouts

Critics of the bailouts have been very vocal, and their ideas have received a lot of publicity, but there are also defenders of the bailouts. The most fundamental argument in support of bailouts is that they are occasionally necessary when the ups and downs in the economy (oscillations) become so severe that chaos looms. Supporters of bailouts argue that during these times government needs to intervene to reduce the oscillations. They compare the current economic gyrations to the physical gyrations that occurred when the Tacoma Narrows Bridge collapsed. High winds caused oscillations that became progressively more severe until the bridge collapsed in spectacular fashion. Supporters of bailouts argue that government must stop the oscillations in the economic system before they cause a disaster.

The defenders of bailouts also argue that they are necessary to protect jobs. The view is that it would be disastrous to lose all those auto workers' jobs because the people who have those jobs spend a lot of money on a wide variety of goods and services. If those expenditures stopped, the economy would suffer greatly. A study by the Centre for Spatial Economics found that the failure of any of the Big Three domestic car makers would throw Ontario into a deep recession, and 157,000 jobs would be lost (auto production workers, auto dealers, auto parts suppliers, and professional services that are tied to the auto industry). In addition, GM spent $14 billion in 2007 buying products and services from other Canadian companies, and those other companies employ thousands of additional workers. All those workers spend a lot of money and boost the economy. They also pay a lot of income tax, and the government does not want to lose that revenue.

Questions for Discussion

1. On pp. 13-16 of the text, there is a discussion of the different roles that government plays in the Canadian economy. Which of the roles is government playing when it gives bailout money to businesses?
2. Do you think that providing bailouts to businesses that are in trouble violates certain fundamental principles on which the Canadian economy is based? Explain your reasoning.
3. Supporters of bailouts argue that in crisis situations the government needs to step in and try to stabilize the economy so that chaos does not occur. Do you agree or disagree with this view? State your reasons.
4. Given the information presented above, do you think that the Canadian government should have given bailout money to GM and Chrysler? Defend your answer.

Sources: Derek DeCloet, "Why GM Survives but Nortel Doesn’t," The Globe and Mail, June 23, 2009, p. B2; Tom Krisher, "Chrysler Factories Reopening," Winnipeg Free Press, June 18, 2009, p. B6; "Is Troubled Air Canada Next on Feds’ Bailout List?," Winnipeg Free Press, June 17, 2009, p. B7; "Ottawa Gives Pulp Mills $1B Lifeline," Business News Network, www.bnn.ca/news/10177.html; "No Easy Road for Chrysler," National Post, June 11, 2009, p. FP1; Gwyn Morgan, "Apocalyptic Rhetoric Aside, GM Bailout is a Bad Idea," The Globe and Mail, June 8, 2009, p. B2; Terence Corcoran, "Still the Same Old Auto Game," National Post, June 4, 2009, p. FP13; Kristine Owram, "Bailout Keeps GM Alive," Winnipeg Free Press, June 2, p. B3; Philip Marchand, "Payback on Auto Bailouts Dubious; Little Debate," National Post, May 30, 2009, p. FP1; Shawn McCarthy and Greg Keenan, "Canada Set to Take Large Stake in GM," The Globe and Mail, May 29, 2009, p. B1; Konrad Yakabuski, "$1.4 Million for Every Job Saved," The Globe and Mail, May 29, 2009, p. A1; Shawn McCarthy and Karen Howlett, "GM-UAW Deal Puts Pressure on Canadian Counterparts," The Globe and Mail, May 22, 2009, p. B1; Roger More, "How GM Lost Its Way: Too Much Cost, Too Many Carsâ€"Too Bad for the Big Three Automaker," National Post, May19, 2009, p. FP11; David Brooks, "Money for Fools," National Post, February 23, 2009, p. A12; Nicolas VanPraet, "Tories Reject Auto Bailouts; Liberals Critical," National Post, March 1, 2008, p. FP7.