With news in the past few weeks of General Motors (GM) dialing back on its operations by cutting 15 percent of its workforce in order to reduce its losses through the idling of plants in Maryland, Michigan, and Ohio, along with reducing its product line, scrutiny of GM’s operations and the auto bailout of 2008-09 are back in full swing.
But for opponents of the auto bailout of a decade ago, GM’s current predicament serves as vindication regarding why the government should not meddle in the marketplace in order to save failing industries. In response, supporters of the bailout ask what would have happened to the American auto industry without the bailouts, with the implicit assumption being that GM might not exist today.
The market economy is more accurately described as a “profit and loss system” in which profits and losses steer scarce resources (i.e. labor and capital) from less able entrepreneurs and inefficient industries to more able entrepreneurs and more efficient industries.
But in the midst of this back and forth, proponents of the bailouts—and probably even some opponents—miss something. They miss the importance of loss and bankruptcy within the market economy, why their operation should not be hampered, and how they help in steering resources towards their most effective uses. An understanding of this concept is at the heart of understanding why bailouts undermine the market economy.
Loss and Bankruptcy
The market economy is commonly referred to as a “profit system.” While true, this description misses the bigger picture. The market economy is more accurately described as a “profit and loss system” in which profits and losses steer scarce resources (i.e. labor and capital) from less able entrepreneurs and inefficient industries to more able entrepreneurs and more efficient industries. If anything, the loss (and bankruptcy) part is probably the most important one.
Entrepreneurial profits signal the creation of value due to accurate entrepreneurial foresight and judgment of consumer needs and wants. As a result, labor and capital are steered into industries that promise high rates of profit from less efficient industries. This helps to increase production, which in turn helps bring down prices of products and services until the rate of industry profits comes in line with the average rate of profits within the economy. This seamless process goes on and on, with some industries expanding while others contract even as the overall economy expands.
Proponents of bailouts fail to grasp the fact that companies like GM are not abstract entities but entities that have assets (in the tens of billions) ranging from manufacturing space and machinery to financial assets.
Entrepreneurial losses signal that value is not being created due to the lack of accurate entrepreneurial foresight and judgment of consumer needs and wants. As a result, industries that report losses have to restructure and reevaluate their business models in order to stay profitable and avoid bankruptcy. Restructuring can take on the form of reevaluating product lines and eliminating unprofitable products, cutting down on labor, or reevaluating the cost of inputs. These actions free up resources such as labor and capital for more urgent needs.
Having a static mentality, proponents of bailouts fail to grasp the fact that companies like GM are not abstract entities, but entities that have assets (in the tens of billions) ranging from manufacturing space and machinery to financial assets. Further, they also have skilled technical talent that is always highly sought after. Even in the event of restructuring or bankruptcy, these resources don’t disappear.
In the liquidation process, in order to pay off creditors and investors, these resources are usually sold—often at bargain prices. Thus, alert entrepreneurs who otherwise might not have been able to afford such resources snap them up and put them to alternative uses unseen by many. Skilled laborers, like engineers and assembly line workers, are also able to take their expertise to other manufacturers. In some cases, skilled labor is able to transfer their skillset into adjacent industries, where new technologies and innovations can be developed.
Bailouts and Fragility
During the GM bailout, one of the arguments advanced in favor was that GM going under would decimate many towns and cities economically. While true, this insight highlights the unseen distortionary effects that bailouts perpetuate. GM’s continued presence in many towns and cities has probably hampered the creation of more diverse economies and has left such places less able to weather economic shocks. To borrow Nassim Nicholas Taleb’s terminology, which primarily applies to the financial industry but can be applied to many phenomena, these cities and towns were fragile (i.e. easily susceptible to disorder and shocks) rather than anti-fragile (i.e. not easily susceptible to disorder and shocks and, in fact, able to gain from disorder by becoming more robust).
With news of GM’s woes, Elon Musk announced in a CBS 60 Minutes interview last week that he was considering buying some of GM’s idle plants in order to manufacture Tesla sedans.
Around the time of the GM bailout, seismic changes began taking place in the mobile phone industry that ushered in the proliferation of smartphones. Finnish mobile phone maker Nokia, which at the time had a share of 40 percent of the global mobile phone market and contributed 25 percent to Finland’s economic growth from 1998 to 2007, was in the early stages of being dethroned by America’s Apple and South Korea’s Samsung. In the face of loss and no bailouts, the story of how the town of Tampere, where Nokia did the bulk of its manufacturing, adapted is a story barely talked about.
When Nokia’s mobile phone division began floundering, staff from Nokia took their skillset and began forming startups and other technology businesses in and around Tampere. Further, Nokia has since concentrated its efforts on making equipment for telecommunications companies, which has turned out to be highly profitable, though not as glitzy as making mobile phones.
Elon Musk’s proposal demonstrates the dynamic process of loss (and bankruptcy) at work.
Though this transition did not happen without difficulty, which still lasts to this day, some say this was a blessing in disguise because the town emerged with a more diverse economy. If anything, the town became more anti-fragile and is better positioned to weather future shocks.
Elon Musk to the Rescue
With news of GM’s woes, Elon Musk announced in a CBS 60 Minutes interview last week that he was considering buying some of GM’s idle plants in order to manufacture Tesla sedans. Though Tesla is a creature of subsidies and interventionism, which puts the future viability of its business model in question in some quarters, Elon Musk’s proposal demonstrates the dynamic process of loss (and bankruptcy) at work.
With an average Tesla sedan out of the reach of many middle-class American families and with Tesla beginning to experience capacity issues at its plant in Fremont, California, the infusion of resources from GM could help address some of these issues. Further, since Tesla’s assembly lines are in California, which is far away from the bulk of American automobile assembly lines in the Midwest and the American South, such a move would put Tesla in close proximity not only to key markets on America’s east coast but also to industry resources and talent.
The “loss” part in the phrase “profit and loss” is probably seldom mentioned because as humans, we don’t like to lose and are wired toward delaying tough choices and decisions. But this part is very critical, if not the most critical. It’s probably the obscuration of this part that is at the heart of the lack of understanding surrounding bailouts, why attempts to save dying and inefficient industries are counterproductive, and of how they only help impoverish general society while leaving communities fragile and hampering creativity and innovation.