Thesis on "Should General Motors Be Saved Reasons for and Against"

Thesis 10 pages (3295 words) Sources: 11 Style: MLA

[EXCERPT] . . . .

GM Bailout?

Introduction to the General Motors Bailout

No sooner had Barack Obama been elected President then House Speaker Nancy Pelosi was on NPR claiming that the most important order of business was to arrange a bailout of the Big Three U.S. automakers. This announcement came as something of a shock, given that the issue had not received much press to that point. The Bush administration had floated the industry $25 billion in 2007 and again in September of 2008, but the issue was given a new sense of urgency by Pelosi's public discussion of the issue (Langfitt, 2008). At the time, a bailout of the banking industry had already been orchestrated. This bailout was precipitated by the failure of Lehman Brothers and the last second acquisition of Washington Mutual by JP Morgan Chase. Insurer AIG was essentially nationalized, with the government taking a nearly 80% stake. This occurred because AIG was considered "too big too fail." AIG-backed securities were owned by governments and financial institutions around the world, such that if AIG failed the global financial system was at risk of collapsing (Karnitschnig, 2008).

The U.S. auto industry, however, was not subject to the same pressures. The global transportation industry was not in danger of collapse. With the possible exception of Canada and Mexico, other nations would not suffer substantial damage if the Big Three went under. The two situations seemed very different from one another, and as a result the proposed automaker bailout immediately came under fire. The controversy was exacerbated by the actions of the Big Three CEOs, who famously flew private jets to Washington DC to ask for a handout from the taxpayers (Ross & Rhee, 2008).

The automaker bailout remains a highly controversial idea. Free market advocates point out that the problems at U.S. automakers are of their own making -- poor products, high production costs and overly generous union contracts among the issues. Proponents of the bailout argue that the benefits will outweigh the costs; opponents argue that the costs are unknown because the businesses are not viable. General Motors is at the center of this controversy, with the government recently taking direct involvement in the situation, firing CEO Rick Wagoner and infusing cash as a bridge until a deal can be worked out to save the company in the long run.

This paper will examine the issue of the GM bailout. There are economic and social consequences to both bailing out GM and letting it fail. There is also the third option -- the one the government appears to be leaning towards -- of propping the company up, doing some restructuring and finding a buyer. The economic theories will be outlined and applied to the situation in an attempt to come to a conclusion about the value of bailing out General Motors. The company's situation is unlike that of bailed-out financial firms like AIG. Those companies were profitable enterprises brought down by the actions of one unit. General Motors is more of a systemic basket case. The government took an equity stake in AIG, one that it will likely be able to sell for a profit after the company has been turned around. The government is not taking an equity stake in GM, so there is no profit opportunity. These facts are at the heart of the controversy.

History

General Motors began in 1908 when a manufacturer of horse-drawn vehicles moved into automobile production. Soon Oldsmobile, Cadillac and the future Pontiac were absorbed into Buick, providing the foundation for General Motors. The company was able to grow rapidly and expanded internationally early in its life. The company prospered in the post-war era but by the 1990s competition was beginning to take its toll. For the last couple of decades, General Motors has bled market share in its core U.S. market, dropping from 33% in 1992 to 18% today (Flint, 2009). They have attempted to fill that revenue cap with improved overseas performance, opening plants in China and Brazil (GM.com, 2009).

The problems at General Motors are myriad. Their design has been so poor that they hired an outsider to help redesign their cars (Flint, 2009). They staked their growth plans in the 2000s on products like the Hummer, an anachronism that appealed to a fairly limited subset of consumers. The losses continued to mount. The last time GM turned a profit was in 2004 (MSN Moneycentral, 2009). Since then, GM has lost $80 billion (Flint, 2009). More alarming, the firm's revenues have been decreasing at a rapid pace. Revenues in 2006 were $204 billion; revenues in 2009 were 28% lower at just under $149 billion. Compounding the revenue declines, GM has seen a steady increase in its cost of goods sold over to nearly 98%. In the face of declining sales, the company has been unable to trim the fat, with selling/general/administrative expense not shrinking alongside sales (MSN Moneycentral, 2009).

As a consequence of their terrible operating performance, GM has seen a steady deterioration of its balance sheet. The current ratio, a measure of liquidity, was 1.06 in 2004. By 2008 it was 0.51 (Ibid). By the end of 2008, cash and receivables were insufficient to meet short-term obligations -- General Motors was on the very of bankruptcy.

Proponents of the Bailout

The situation being as dire as it is, there are many good reasons to bail out General Motors. The economic consequences of a GM failure are potentially catastrophic. There is both direct damage and indirect damage. In terms of direct damage, General Motors employs 243,000 people overall. Its salaried workforce in the U.S. is estimated to be around 28,300 people (Langlois & Hinton, 2009) and its hourly workforce is 62,400 (Krisher, 2009). These jobs are situated largely in the nation's more economically depressed areas -- in the so-called "rust belt." These jobs would be lost, and there is little indication that other automakers would be able to hire these workers, as there is industry-wide overcapacity. Not only would current GM workers and their communities be impacted if General Motors was allowed to fail, but the retirees would face consequences as well. There are an estimated 600,000 General Motors retirees (Walsh & Hakim, 2005), again predominantly located in the rust belt. The GM cash crunch has already cost this group its medical benefits, and bankruptcy would likely result in even greater losses (Bunkley, 2008). Reduced income for GM's workforce and retirees will have a trickle effect throughout the region, hurting stores, restaurants and other businesses as consumer spending drops in affected regions.

As bad as the direct impacts on GM's past and present workforce will be if the company is allowed to go bankrupt, the worst consequence is the impact on the automobile industry as a whole. It has been argued that the economic cost of allowing GM -- or any of the Big Three -- to fail would be upwards of 3 million jobs and $150 billion in tax revenue. A General Motors failure would impact its suppliers. There are very few automobile manufacturers so industry suppliers would be unable to make up the lost revenue. Since many suppliers deal with multiple car companies, there would be a substantial ripple effect if the suppliers began to fail after losing GM revenue (Krisher & Thomas, 2009). Worth noting is that the $50 billion in tax revenue does not even value the total economic cost as entire communities are gutted, pensioners lose their income and workers are left unemployed. The social and economic effects would be devastating.

The hundreds of billions of dollars that a GM failure would cost the economy are much larger than the tens of billions of bailout money. If the government were to bail out General Motors, it would merely be acting rationally. As costly as a bailout is, and as unpalatable, it is preferable to the cost of letting GM fail. The domino effect would be too substantial, crippling the nation's industry heartland, forcing millions onto unemployment rolls right at the time when the government is already battling skyrocketed unemployment.

A final argument of proponents is that General Motors is necessary for the nation's security. The national security argument is based on the presumption that in a time of war on a cataclysmic scale there are certain resources, skills and capabilities that a nation must have on its own, without relying even on its allies. There is a certain irony in how a nation completely incapable of meeting its own energy needs is concerned about maintaining the capacity to build vehicles for which it would not have fuel to run. Yet, proponents nonetheless make the case that the U.S. needs to have a certain level of automobile manufacturing capacity for the interests of national security, although this claim has been disputed by military leaders (Gold, 2008).

Opponents

Opposition to the bailout comes from many corners. Taxpayer advocacy groups and libertarians decry government involvement in business on principle. Free marketeers argue that government intervention creates an economic distortion, which… READ MORE

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