Congress is entertaining a $25 billion bailout of the autos. The President and Secretary of the Treasury are OK with this as long as it doesn’t come out of the $700 billion TARP money.
To the average person, the problem with GM is well known. Indeed, most realize that there have been fundamental, structural problems for the past 20 years.
We have been beaten at a game that we invented.
There is no doubt that a failure of GM would be disruptive to markets. This must be balanced by the fact that doling out to GM will cause a rush of suitors looking for government dough.
Most importantly – will it solve the problem?
First, let’s get the history right. The title quote is not quite accurate. In 1953, Charles Erwin Wilson (who was president of GM) was nominated to be the Secretary of Defense. In answering a question before the Senate Armed Services Committee, he said he saw no conflict of interest between GM and his new job “because for years I thought what was good for the country was good for General Motors and vice versa.”
I don’t think this quote applies any more.
Right now the debate is focused on whether we should bail out GM or let it go into Chapter 11.
What we know
- GM’s problems are not new but have been exacerbated by the recent economic downdraft.
- GM costs of production are way out of line. While some estimation is necessary, the hourly cost for a GM laborer is about $70 per hour. Toyota is less than $50 per hour. Roughly speaking, GM pays 40% more than Toyota. GM cannot be competitive with this differential.
- The UAW has made it clear (November 13, 2008) that they are unwilling to make further concessions: “We’ve made concessions and done everything we could to make the company profitable over time,” a UAW official told Bloomberg.
- Paying a premium wage is OK – if there is higher productivity. But that is not the case – it is the opposite. The quality of GM production (yes, I know there are some exceptions) is inferior to its competition.
- This is not just a blue collar problem. While data are not as easily available, it is reasonable to think that the white collar cost greatly exceeds those of competitors in Japan in Germany.
- This is not just an issue with costs. Management has made strategic choices that bear considerable responsibility for today’s mess. That is, simply rolling back the costs will not put GM on the right course to be competitive in the future.
- The most serious strategic mistake was the consistent underinvestment in research and development by GM (and Ford) compared to its competitors over many years. This is a classic example of trading off the long-term for some extra cash in the short term. [For more on the short-term/long-term trade off, see my post "My Warning in 2005".]
What we don’t know:
- What is the story with GM’s pension plan? They are saddled with a massive defined benefit program. With the recent collapse of the stock market, they must be underfunded – the question is by how much. The U.S. Pension Benefit Guaranty Corp (PBGC) said today that GM has not been responsive to the agency’s requests for updated information on the pension plans. My guess is that the pension obligation alone, if known, would drive the stock to near zero value.
A few observations
- Simply doling out money will not solve the structural problems. It will just buy some time. I know that sounds like Richard Shelby – but I think most people agree with this statement. However, it does not mean we do nothing.
- In the ideal world, we could have a Chrysler-like “investment,” like an unofficial Chapter 11 with debtors taking haircuts and labor contracts being renegotiated. Politically, I think it would be impossible to broker this.
- A Chapter 11 would be disruptive – few would buy a GM car because the warranty would have a big question mark on it.
- No one wants to see hard-working Americans laid off.
- GM is strategically important for the U.S. economy. For example, many firms that supply the defense department do important business with the autos.
What I would recommend:
- Government should consult with the UAW and offer a deal: either all contracts are reopened and radically renegotiated to make GM competitive, or the firm will go into Chapter 11. The UAW should also be told that competitive compensation will be applied at all levels (white and blue collar). My guess is that Chapter 11 is the outcome. To me, it is the only politically feasible way to renegotiate the contracts.
- Assuming a Chapter 11 is the outcome, the government immediately steps in and guarantees all warranties. This keeps GM operational.
- Stock holders will get zero. Bond holders will take a haircut. GM gets a chance to radically reorganize. The reorg will produce a smaller firm with far fewer models.
- New management is injected.
- Government provides investment in the New GM (and gets warrants). A precondition of the investment is that R&D spending must not fall below the average of the most prominent foreign competitors.
- Government does its best to minimize the negative impact due to the inevitable loss of jobs. This might include relocation stipends for people moving out of the production areas, education stipends for retraining and could even include extra infrastructure investment in hard hit areas (that would generate employment).
I know this is tough medicine and will not be easy to pull off. While Ford is in a stronger position than GM, it is obvious that it faces some of the same issues with respect to competitiveness. While I have focused on GM, any solution must involve all the autos. The goal, of course, is to rejuvenate this important component of our industrial structure. While our economy has shifted towards being a service economy, I believe it is important to retain strength and have a diversified economy. GM should play a robust role in economy. Right now it is just a weak link.