Auto Companies: to save or not to save?

After the US government warned General Motors (GM) and Chrysler to shape up or go bankrupt, there has been a huge uproar from many people. The argument goes that if the US government is ready to spend hundreds of billions of dollars to save the banks, then why not spend a few billion dollars to save the auto companies? Although the argument may sound convincing, there are some key reasons as to why the US government should not bail out the auto companies.

The fundamental difference between a bank and any other company is in the service that they provide. A bank’s basic function is to take money from the government (or the Federal Reserve in the US) and loan it out to people and companies. This money forms the basis of all economic activity. Without the banks, corporations will not get money to perform their day-to-day activities. People will not be able to buy things on loan. Companies will not be able to expand their business. The economy will simply collapse.

The auto industry on the other hand, is not as critical to the economy. The industry does employ a lot of people, and also supports a lot of auto-ancillary factories (which in turn employ even more people). However, in case a GM goes bankrupt, there are other car makers (especially efficient companies like Honda and Toyota) which will keep producing cars. Employees from GM can potentially find jobs at other car makers (assuming aggregate demand for cars does not drop sharply).

When the economy was booming; GM, Ford and Chrysler kept on making bigger and more petrol-consuming cars. People were readily getting loans and they kept on buying. As oil prices shot up and the economy went down, the demand for big cars disappeared. The US auto companies suddenly found themselves at a huge disadvantage to companies like Toyota, which had successfully invested in electric and hybrid technology.

The US auto makers are also struggling with huge costs of employees and labor unions, which are a big drag on profits. With falling demand, these companies cannot re-size the workforce as needed.

The simple truth about the US auto makers is that they make more cars than there is demand for, and most of the foreign car makers make better cars at lower cost.

One of the benefits of an economic downturn is that it allows good companies to flourish and destroys uncompetitive companies. As long as uncompetitive companies are allowed to fail, there will be other leaner and better companies taking their place and the economy as a whole will be better off. The best course of action for the US government would be to allow the auto companies to fail. If the government keeps providing these companies with cash, it will promote unhealthy competition (with other countries like UK, Canada, France, Italy, etc. also being forced to subsidize their auto companies).