A Simple Argument Against the Auto Bailout: A Bailout Would Destroy Jobs.

I have hesitated writing about the GM bailout for two reasons. First, I like GM cars; I bought two of them in March, and every car I've ever bought was a GM car. Second, a professor with tenure should be somewhat circumspect in writing about the jobs of people who do not have the protections that we have.

But in watching CNBC debates on the Auto Bailout, I have been frustrated by the arguments of those who favor bailouts that government largesse will on balance lead to more employment, rather than less.

Those inclined against the bailout seem mostly to say, "When will the handouts end?"

Yet the best way to meet the "jobs argument" is with another jobs argument. Making bad, uneconomic investments in failing industries does not, on balance, preserve jobs; it tends to destroy more jobs -- and more good jobs -- than it saves.

If you give money to failing industries to save jobs, then you are probably taking even more jobs away from other industries who would hire or retain workers but for their higher expenses. In essence, throwing money down a hole may preserve jobs in the short term but should lose jobs in the medium and long term.

If you pay for an auto bailout with today's tax money, then over the next couple years you are taking jobs away from lots of people currently working.

If, on the other hand, you pay for today's auto bailout with an increased deficit, then lots of future workers will be unemployed or take worse jobs in order to pay for today's auto workers. Again, you would be taking jobs away from lots of people (mostly in the future) to preserve the jobs of auto workers and their suppliers today.

Heavily unionized businesses usually have trouble competing with non-unionized businesses. Unions are successful in getting above-market wages and benefits, which makes it difficult for the businesses to compete. In the auto industry, there are many more dealerships than necessary. And, according to Larry Kudlow, the average compensation and benefit rate for auto workers in Detroit is $72 an hour, compared to $44 an hour for foreign car workers at US plants.

Even if two of the three Detroit automakers were to go out of business, most of their workers and the workers for their suppliers would be able to get some sort of job. That the jobs they would get would pay a lot less suggests just how much they are overpaid now. If General Motors has become a health and pension plan that makes cars on the side -- in other words, unions pressured bad management to make promises they couldn't keep -- then inducing GM to go out of business should be on balance good for the economy. Any government bailout should go to the Federal Pension Benefit Guarantee Corporation, to provide money to cover partial pensions for the employees of companies in the bankruptcies certain to come.

As with so many problems, it is unlikely that GM would have made such foolish deals if the government had not forced it to bargain with striking workers, rather than simply replace them. As with mortgages in the banking industry, the federal government pressured businesses to make deals that were economically bad for the businesses involved.

If an industry is contracting and there is an oversupply of productive capacity, then the worst thing we could do is prop up that industry by taking jobs away from the healthier portions of the economy (including better run automakers). If government planners really were a lot smarter and better planners than business people (they aren't), then the government's strategy should be to try to drive bad businesses out of business quicker, not try to destroy the healthy companies by propping up the dying companies.

The argument that the auto unions and the auto executives have already made sufficient givebacks is not credible. And as the Congressmen pointed out, the Detroit executives could have flown to Washington on commercial flights (in first class), instead of in private planes. If a business is failing, union auto wages should be priced well BELOW what nonunion auto workers make, not well ABOVE what nonunion workers make. So until the unions have given back everything above the market value of their labor, they haven't given back nearly enough. I don't know enough about what goes into the $72 compensation rate, but perhaps the parties should consider having all current employees, both management and union workers, take a 50% pay cut.

The only job-saving justification I can think of for a Detroit bailout is if the problem were only temporary; then destroying jobs might be imprudent. If Detroit's business model were strong, if there were little or no overcapacity, and if Detroit's problems were only temporary, then one could reasonably think that a bailout might be efficient. But there is no temporary market failure here to redress. Detroit's problems have been here since the late 1970s.

Anyone who thinks that giving money to a company losing 2-3 billion dollars a month — with overpaid workers and overpaid executives -- would usually save jobs in the long run, rather than lose them, doesn't understand economics.

UPDATE: I see that David Yermack said it better.

In 1993, the legendary economist Michael Jensen gave his presidential address to the American Finance Association. Mr. Jensen's presentation included a ranking of which U.S. companies had made the most money-losing investments during the decade of the 1980s. The top two companies on his list were General Motors and Ford, which between them had destroyed $110 billion in capital between 1980 and 1990, according to Mr. Jensen's calculations.

I was a student in Mr. Jensen's business-school class around that time, and one day he put those rankings on the board and shouted "J'accuse!" He wanted his students to understand that when a company makes money-losing investments, the cost falls upon all of society. Investment capital represents our limited stock of national savings, and when companies spend it badly, our future well-being is compromised. Mr. Jensen made his presentation more than 15 years ago, and even then it seemed obvious that the right strategy for GM would be to exit the car business, because many other companies made better vehicles at lower cost. . . .

Over the past decade, the capital destruction by GM has been breathtaking, on a greater scale than documented by Mr. Jensen for the 1980s. GM has invested $310 billion in its business between 1998 and 2007. The total depreciation of GM's physical plant during this period was $128 billion, meaning that a net $182 billion of society's capital has been pumped into GM over the past decade -- a waste of about $1.5 billion per month of national savings. The story at Ford has not been as adverse but is still disheartening, as Ford has invested $155 billion and consumed $8 billion net of depreciation since 1998.

As a society, we have very little to show for this $465 billion. . . . Yet one can only imagine how the $465 billion could have been used better -- for instance, GM and Ford could have closed their own facilities and acquired all of the shares of Honda, Toyota, Nissan and Volkswagen.

The implications of this story for Washington policy makers are obvious. Investing in the major auto companies today would be throwing good money after bad. Many are suggesting that $25 billion of public money be immediately injected into the auto business in order to buy time for an even larger bailout to be organized. We would do better to set this money on fire rather than using it to keep these dying firms on life support, setting them up for even more money-losing investments in the future.