Sunday, May 31, 2009

GM, Chrysler, Lies and Statistics

One of the truest thing ever said is that there are lies, damn lies, and then statistics. One shouldn't confuse statistics with underlying truths. It is easy to become obsessed by statistics, and lose sight of underlying truths.

The Gross Domestic Product (GDP) is a measure of economic activity. In essence it consists of adding up all expenditures for consumption, investment (without accounting for depreciation), government, and exports, and then subtracting imports. GDP, therefore, can be said to measure total national spending. If the government focuses on boosting GDP, then increasing any of these types of spending serves the policy. And when times are good, it may not seem to matter if $1,000,000 is spent investing in a chain of franchised hair salons, a small software company, or a machine tool shop.

However, not all economic activity is the same. That becomes clearer when times are tough. As the unemployment rate rises and the nation looks for ways to create jobs, the need for more hairstylists to give $100 haircuts is a lot lower than the need for skilled computer programmers to create ingenious new software or for skilled workers to operate the precision machine tools used to produce high quality equipment. Economic strength comes from having strong core industries that produce essential or important products. One can't build lasting wealth by processing documents for refinancing mortgages or underwriting asset securitizations. There have been many economically healthy times without refi transactions or a securitization market. But true economic strength is difficult to attain without robust industries that make tangible and valuable products.

That's why the government's bailouts of GM and Chrysler from bankruptcy make sense. Manufacturing motor vehicles not only employs a lot of people, it also uses a lot of technology. Modern cars and trucks require advanced materials; sheet steel isn't enough. They also contain a lot of computing power--dozens of tiny computers are built into today's cars and trucks to do everything from regulating the mixture of fuel and air going into the engine's cylinders to triggering the air bags to operating the GPS system. The days when a 17-year old kid could work on a car with a couple of screwdrivers and a set of socket wrenches are long gone. Thus, the auto industry supports a variety of sectors of the economy.

It also helps to preserve critical manufacturing skill sets. Only a small number of nations have skilled workers who can operate precision machine tools, the foundation of any advanced manufacturing industry. The machine tool industry makes the machines that make the cars, airplanes, and goods that we consume. If you've ever wondered how the HVAC system in your house was made, it was made by machines that were built by the machine tool industry. Without machine tools, we'd be back in the 18th century, relying on fireplaces and open windows. Machine tools also built the machines that built the tractors, harvesters and other equipment used by farmers. Food would be much more expensive and less abundant without machine tools.

The government will no doubt do some dumb and silly things with GM and Chrysler. There are fears that bureaucrats may end up deciding how many cars will be blue and how many will be red. Or how many models and options will be available. Surely, on a day-to-day, granular level, some of the taxpayers' money will be wasted. When that happens, the press will have a field day playing gotcha journalism, which will curb any bureaucratic inclinations toward micromanagement.

Government subsidies have been crucial in the nation's development. The settlement of the vast farmlands of the Midwest and West was facilitated by the Homestead Act and the government's subsidies to the railroads, which could cheaply ship goods to farmers and bring their harvests to the populous East. The Postal System's mail delivery contracts were crucial to the infant commercial airline industry in the 1920s and 1930s. The Interstate Highway system speeded up all economic activity. The Internet began as a Defense Department experiment, and has evolved into the biggest information revolution in history.

The auto industry historically led the way out of recessions. This time, things will be different. GM and Chrysler have shut down a number of plants and largely halted production for the next few months. They and their suppliers have laid of hundreds of thousands, and many more layoffs are likely by the end of the summer. Production, we hope, will then resume. But without the tens of billions dollars in government bailouts, GM and Chrysler would very likely be headed toward liquidation. In that case, which American industry would lead the way out of recession? There aren't many good candidates.

The government bailouts of GM and Chrysler aren't a sure bet. The taxpayers could be taken to the cleaners. But what's the alternative? A trip to the cleaners anyway for heightened recession, increased unemployment compensation and Medicaid costs, and ripple effect bankruptcies of suppliers and the unemployed. In some communities, the tertiary impact might even lead to municipal bankruptcies and unheated classrooms. Trillions of dollars of federal bailout money has been expended to stabilize the banks. Bank stocks are doing better, and refi activity is up. But you can't build a strong economy just by refinancing mortgages, even if the increased spending from refi increases GDP on a statistical level. We took that approach recently, in the early 2000s, and things didn't turn out so well.

The financial system cannot become truly healthy, and the economy cannot truly recover, until the real economy revives. That's why the GM and Chrysler bailouts, as distasteful and risky as they may be, are sound government policy.

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