Should the Government Bail out the Auto Industry - Essay Example

Is Bailing out Automobile Industry in USA is necessary? Is Bailing out Automobile Industry in USA is necessary? of the College Professor’s Name Name of the Subject Abstract Bailing out of automobile industry has become essential as it will have larger effect on American society and jobs in U.S.A. If auto industry is allowed to go down, then it will have greater effect on their suppliers, employees, middle-class society that reckons upon automobile industry. If auto industries file a chapter 11 petition or if it declares a lock-out, it will have greater implication on communities whose infrastructure and housing may become nearly unimportant. This research article the need for extending bailout packages to U.S major auto industries with past empirical evidences for the overall benefit of U.S economy. Is Bailing out Automobile Industry in USA is necessary? US Automobile industry – a general review The automobile industry of USA currently is providing employment for more than one million Americans. Further, US automobile industry is dominated by three major players namely Chrysler, General Motors and Ford. However, from the year 2003, the scenario in the U.S. automobile industry has dramatically transformed. At present, the lion’s share of cars sold in the U.S market were either assembled or manufactured by foreign manufacturers at their new North American manufacturing units which is famously known as “transplant facilities” or imported. Due to cut throat competition, the big three U.S. auto majors now have to concentrate only in light trucks manufacturing and even there, they are being encountered by competition from foreign manufacturers. Since 1980, on financial ground, the major three big players of U.S.A have laid off more than 600,000 jobs. Michigan has been the worst affected state since more than 100,000 individuals have lost their jobs in the automobile industry since 1980. It is to be noted that in 1980, Regan administration had been urged to negotiate quotas on imports from Japan. Nonetheless, by and large U.S deficit in automotive trade deficit in automotive commerce had enlarged from $ 10 billion in 1979 to in excess of $150 billion per annum in 2000 despite of high quantum of inward remittances by foreign automobile manufacturers and a fall in the imports as foreign model cars have been manufactured at transplant assembly facilities in U.S.A itself. In 1980, U.S. had framed policies intended at demanding foreign automobile manufactures operating from America to manufacture more of the model of cars that they sell to America and some other policies intended at increasing awareness of consumers about imported vehicles and automobile parts, like the American Automobile Labeling Act, seem to have had no effect on the increase of this sector’s trade deficit. In 2004, the trade deficit with the Japan was more than $48 billion and the U.S exports to Japan were just $ 2 billion Further, U.S.A trade deficit with Korea was nearly $12 billion whereas the American exports to Korea was only $1 billion in 2004. The main reasons for the huge trade deficits with Japan and Korea are due to imports in the automobile sector. Further, the growth of American automobile industry is badly impacted due to environmental issues like fossil fuel consumption, vehicle emissions which have played an ever increasing part in formulating the U.S. auto industry policies. Environmental decisions have greater impact on the automotive sector like designing the product, researching on novel vehicles and marketing the same to consumers. The outlook for American automobile industry is not so encouraging. Since 2000, sale of automobiles have been maintained at a greater level but with only liberal offering of manufacturer’s incentives. Since 2000, neither total production nor sales have grown considerably. Both GM and Ford are able to achieve the targeted sales with liberal incentives since 2001 but at the cost of decreasing current profits and future demand. If automobile manufactures in U.S.A have prolonged to promote their sales through financial incentives, then higher interest rates will increase the cost of incentive offered and will in turn minimize the earnings. Further, three automobile major players in U.S.A have been adversely impacted by “legacy costs” like increasing share of contribution to pension funds and health care benefits for retirees. Thus , as far as the U.S.A automobile industry is concerned , the outlook for this industry as at the start of 2005 were not as healthy as in many other sectors.(Cooney , Yacobucci & Brent ,2006,p.10). The American Auto industry is under siege. The current automobile industry’s predicament is not because of failures of management of auto industries in U.S.A in general but due to the onset of global financial crisis. If USA government fail to approve the auto bail-out packages, there will be not only America’s GDP could be lost by 4% but also loss of million of jobs. However, critiques argue that that automobile industry was searching for regaling the wounds that were primarily appears to be self-inflicted. U.S government machinery blames that major auto industries like GM, Ford, and Chrysler’s manufacturing budgets were fell short of its aimed units and its labor costs shoot up rapidly as contrasted to their foreign competitors. However, automobile industry had denied this charge and put the responsibility on the international financial quandary which has severely restricted the availability of finance and diminished industry sales to the ever grimmest per-capita amount since Second World War. (Erbe 2008). Auto industries assert that if no bail-out package is sanctioned to it by the US government as in the case of banking and insurance industry, there will be a deprivation of three million jobs within the first year of quandary which will have major impact on U.S economy. The history of financial predicament of U.S. Automobile industry In 1980, Japan had attained the position of the world’s largest automobile manufacturer. In the year 1980 itself, all the four US automobile manufacturers were financially in trouble due to decreased sales due to Japanese car manufacturer’s competition. In 1980, General Motors posted a loss of $ 762 million, Ford posted a loss of $ 1.5 billion and American Motors posted a loss of $ 156 million. In 1980, Chrysler posted a record loss of $1.7 billion. The invasion of Japanese and Korean competition into the American automobile industry has made a deep inroad in the market share of automobile manufacturers in U.S.A. Trade protection policy perused has been a key mechanism of policy response to the increase of Japanese competition both in North America and European markets. Further, subsidiaries also happened in the guise of bailouts or injection of capital designed at helping restructuring of ailing automobile companies in U.S.A and in other nations. There are other two varieties of subsidization like granting of loans and regional grants as a bait to attract the setting up of the plant in their location, helping to modernization of industry rather than ending up in winding up and R& D funding to introduce more fuel-efficient vehicles. Thus, bailout is not a new phenomenon to the automobile industry in U.S.A in general. In 1980 itself , there were three major automobile bailouts in the world, They were Chrysler ( both in US and in Canada) , British Leyland and Renault and bailouts have helped these companies of restoring the companies back to the course of profitability , though such rationalization has resulted in majority cases key workforce reductions , and in some cases , wage reduction for employees. Government bailout programs to automobile industries in selected countries between 1975 and 1985. France Type of Assistance Year PSA/Renault In Million Eve Research project 1981-85 $62 FIM modernization 1984-85 $300 Loans 1984-85 $306 Capital Injections 1975 to 1987 $2670 West Germany Type of Assistance Year VK/D Benz, Berlin V. In Million Auto 2000 Research project 1980-84 $50 UK Type of Assistance Year BL , Ford , PSA , GM , Nissan In Million Capital Injection 1978-83 $2,612 Regional and other grants 1976 to 1991 $461 U.S.A. Type of Assistance Year Chrysler AMC Loan Guarantees 1981 $1,500 Canada Type of Assistance Year AMC In million Grants 1985-86 $164 Source: Trebilcock et al, 1990. In 1980, due to record loss of $ 1.7 billion, Chrysler was on the brink of bankruptcy. Chrysler’s CEO, Lee Iacocca, chalked out an exceptional government bailout scheme. Iacocca was able to convince the US government that this was in the best interest of the nation to shun major bankruptcy of an American brand. Having given consideration about the employment opportunity for 130,000 employees provided by Chrysler and with Iacocca’s pledge to enforce strict cost-reduction measures was enough to convince the US government to sanction a financial rescue scheme employing taxpayer’s money. In the period between 1981 and 1984, Iacocca withdrew some car lines, reduced inventory levels by $ 1 billion, development of new and promising models and minimized the total strength of Chrysler employees. (Anthony et al, 2005, p.305). The bailout of Chrysler in 1981 consisted Federal government loan guarantees of $ 1500 million. If the bailout was not made in 1981, major actors like creditors, employees, state and local government would have suffered a lot. However, according to Reich, the concessions offered to Chrysler amounted to $2600 millions. Concessions made by other parties with a precondition that US government should back the Chrysler bailout in 1981: Total Concession agreed by July 1981 was $ 2,600 million. Source: Trebilcock et al, 1990. There were many criticisms for Chrysler bailout by U.S government in U.S.A in the year 1981. However, just within two years, Chrysler was again returned to profitability. In 1983, it paid back the federal government loan in full. Trade Adjustment Assistance (TAA) claims made by retrenched employees of automobile industry rose from 131,722 to 388,265 over one year in 1981 and out of this, former Chrysler employees consisted a major proportion. (Aho and Bayard, 1984, p.180). Though, Chrysler had availed U.S government bailout benefits and was able to return to profitability, employees did not fully get back the wages and fringe benefits that existed prior to bailout period. The employees agreed for the wage and fringe benefits cuts mainly to resurrect the Chrysler. However, when Chrysler posted a profit of US$ 2500 million in 1984, employees were never paid back their earlier wages structure and fringe benefits by the Chrysler. Likewise, creditors had foregone their claims for the restructure of Chrysler. However, they were not recompensated when Chrysler returned to profitability in 1984. (Trebilcock et al, 1990, p.101). How GM was revived in 1990? Rick Wagoner, General Manager of GM, was able to resurrect GM in the 1990’s when it losses amounted a whooping $30 billion. Due to Rick’s turn around measures like modernization, cutting costs, enhancing the quality, GM was able to earn $4 billion per year in the middle 1990’s. However, Rick’s attempt was proved to of no use due to GM’s employee’s pension commitments and health-care benefits extended to retirees which stood in the way for the availability of billions of dollars for the development of new models. $1400 has been added cost of every vehicle manufactured at GM due to the employee’s retirement benefits alone which is totally not present for its competitor’s product from European and Asian markets. Due to high demand, loss-making cars of GM have to be manufactured in large quantity and as the result, GM could not concentrate on manufacture of high profit yielding pickup trucks and sport-utility vehicles. General Trend in Automobile industry in U.S It is to be noted that automobile business is a seasonal one and production pattern varies from month to month basis. Due to frequent model changeovers of vehicle and entrants to new market, transition occurs throughout the year. Typically, in auto industry, during the third quarter of a financial year, product changeover and annual plant shutdown will be carried over and hence in the third quarter operations results will be much lesser as contrasted to other three quarters of the year. Further, demand pattern for car is linked to general economic scenarios and consumer spending pattern which will have great impact on the car sales. Moreover, consumer preferences and spending will also be molded by the fluctuations in the price of fuel. Research and development costs is the major overheads in an auto industry as it has to continuously research on improving design enhancement, production, to improve vehicle emissions checks, enhanced fuel economy and improved safety of inmates in their vehicles. For example, GM has spent about $ 8 billion on research and development expenses in 2007 alone. GM is continuously involved in to enhance their internal combustion engines, developing advanced alternative propulsion technology, advanced diesel engines and hydrogen fuel cell technology. Despite of these facts, GM had posted $ 39 billion loss in 2007 which is the highest in the American automobile industry. Is Bailing out Automobile Industry in USA is necessary? Bailing out of automobile industry has become essential as it will have larger effect on American society and jobs in U.S.A. If auto industry is allowed to go down, then it will have greater effect on their suppliers, employees, middle-class society that reckons upon automobile industry. If auto industries file a chapter 11 petition or if it declares a lock-out, it will have greater implication on communities whose infrastructure and housing may become nearly unimportant. Further, if automobile industry breaks down, it will have tale telling effect on employment opportunities in America especially high-paying factory employment which would once for all will disappear from American service-related economy and no one aware whether it will turn back to American society or not. It is projected that job losses would be more than 3 millions which includes both direct and indirect employment losses with loss of jobs by spare parts suppliers and subcontractors. It is to be noted that if no automobile bailout package is announced, these lost jobs will be cherished to life in developing economies in South East Asian nations like China or India where technology and labor is considerably cheaper. Recommendations: To help the American automobile industry and to resurrect from its mounting losses, American government should announce a tax-credit of or up to $ 5000 to encourage consumers if they buy alternative energy vehicles like GM’s Volt. To be viable in the market, automobile industry in USA should develop alternate technology vehicles which will recoup the sagging industry and assist to minimize the country’s dependence on foreign oil and gas. American government should subsidize the vehicles running on ethanol as Brazil has successfully used sugar-cane based ethanol. It should encourage the corn-based fuel as alternate to fossil fuels. US government should assist by granting financial grants to research on hybrid battery powered car that will help to maintain eco-friendly environment and also to boost the nation’s economy. US government should invest in research and development for researching on battery run and fuel-cell run cars. (Washington Times, 2008, p.A01). As a precondition for the auto bailout scheme, US government should insist that industry should have boards of directors who are more accountable. Thus, by insisting that the board should have more participating directors rather than sleeping directors, U.S government should see that automobile industry should have active board of directors which is analogues to board which had been set up in the airline industry immediately after 9/11 attack to resurrect the ailing airline industry then. The airline industry board consisted members from employees from the private sectors and government officials. The revamped automobile industry should establish a good corporate culture so as to forbid a reposition into erstwhile bad practices. 1. What is the role of labor unions in contributing to the financial problems facing the Big Three? In particular, how well do the wages reflect the productivity of the workers in the Big Three? Click here to read more. The labour union of auto industry in US is strong and enjoys the support of US government indirectly. They play a militant and adamant role in not realizing the real situation and not co-operating with the Big Three to reduce their wage level at par with their Japanese competitors. The US labour law demands the Big Three to look into their employee’s healthcare and pension responsibilities. As the result, they are compelled to carry cost between $ 700 and $1500 per vehicle towards employee’s pension benefit which is higher than the cost of their main raw material namely steel. Due to this, they are unable to finance their pension requirements. It is to be noted that Ford, GM and DCX pension funds had surplus funds in 1980s and now they are under funded with a combined obligation of more than $ 53 billion. For instance, in 2002 alone, Ford’s spent $2.8 billion on healthcare requirements. Out of this, $2.1 billion represented UAW-covered hourly paid employees in all the Ford manufacturing units and retirees. This makes them less competitive as compared to Japanese and Asian car manufacturers since their labor cost is considerably low and there are no healthcare obligations to the magnitude to Asian manufacturers as applicable in USA. Instead, one of the main persuasions of the Big Three is to compel the US government to safeguard the jobs in automobile sector by sharing or bearing in whole of the pension obligations of the employees. Currently, the productivity of Big Three employees is comparatively higher than that of its Japanese counterparts in USA. Presently, Big Three has arrived at a settlement with UAU (United Automobile Workers) to bring down the wages of automobile workers in consonance with its Japanese manufacturers like Toyota and Honda. The present hourly rate of a Big Three employee is about $74 per hour and attempts are made to reduce the same to $45 per hour in tune with the wage structure of $45 per hour per employee of foreign competitors in USA. 2. Do you think the problems faced by the Big Three stem primarily from the recent financial crisis or from longer-term decisions about what types of vehicles to produce and how to produce them? Big Three is facing stiff competition from Japanese car manufacturers and struggling to cope with tightening environmental legislations. Further, Japanese technology has built in fuel efficient features which Big Three are lacking. .Big Three appear to be playing a losing game against Toyota, Honda and Renault –Nissan. These companies have established their manufacturing units in USA which is known as ‘transplants.” These foreign automobile manufacturers are manufacturing light trucks and SUV’s with the latest technology which is in high demand in USA. 3. Some suggest that another reason leading to the failure of the Big Three is that American consumers prefer cars made by foreign companies, such as Toyota and Honda, to cars made by American-owned companies. How does the market of foreign-made cars affect the demand for American cars? Japanese made car is having wide market in USA due to the following reasons. 1) It is cheaper. 2. Using the fuel-efficient technology. This helps Americans to save amount spent on high cost gasoline. 3. Concentrating on manufacturing of small cars only. According to U.S Department of Commerce, the popularity of Japanese car is due to their reputation for quality, competitive prices and efficient sales networks. 4. Foreign-owned automakers, like Toyota and Honda, operate production facilities in the United States and employ American workers. How would these firms be affected by a bailout of the American-owned Big Three? How will foreign auto firms with operations in and outside of the United States be affected if one or more members of the Big Three were allowed to fail? For instance, Big Three share of market decreased to 61% of the domestic market in 2002 whereas the U.S assembly market is held by foreign manufacturers which are about 80% of total domestic market. If one or more members of the Big Three were not supported by U.S government, then foreign car manufacturers in U.S will capture the market share held by Big Three. If the bail-out is extended to Big Three , then foreign –owned auto makers like Honda and Toyota will be compelled to pay higher wages to their employees in par with the Big Three employees and as the result , there will be an over all increase in their overhead and may experience sharp decline in their prodigality. 5. How do the loans compare with tariffs in foreign trade? What advantages and disadvantages do they share in common? As per WTO, globalization should focus on free trade. Hence, all member countries are precluded to practice protectionism by imposing high tariffs, levying import quotas etc. U.S.A tackled the issue of dumping of import of Japanese cars in USA by introducing VER (Voluntary Export Restraint). It encouraged the opening Japanese production plants in USA by flow of FDI into USA. FDI has brought latest technology and revolutionalized the automobile sector. Whereas loan grant by US government will help the Big Three to wipe off their loses and to rejuvenate and revive the ailing automobile industry in USA. Loans could be repaid by the Big Three once they start to earn profits. For instance, GM was given financial package in the 1980 when it met the analogous situation. However, later GM was turnaround and it was actually repaid the loan it got it from US government. 6. What would happen to the broader economy if the plants closed and workers became laid off? What might these workers do to find new employment? Which sectors would employ them?   If Big Three plants are allowed to be closed down, it would lead to migration of production and jobs to Asian countries like China, India and Korea as the cost of manufacturing including labor cost is too low in these countries. It would be very difficult to restore these jobs again in America. US government has the responsibility to offer alternate jobs to those who have been laid off during this present economic downturn. It would increase the overall unemployment and US government commitments to social benefits. Overall economic development of the USA would be affected. US government should come forward to safeguard the jobs in automobile sector by sharing or bearing in whole of the pension obligations of the employees. Conclusion: For example, the bailout of Chrysler in 1981 consisted Federal government loan guarantees of $ 1500 million. There were many criticisms for Chrysler bailout by U.S government in U.S.A in the year 1981.However, just within two years, Chrysler was again returned to profitability. In 1983, it paid back the federal government loan in full. A bail-out package of $ 35 billion of loan should be immediately sanctioned to auto industries in U.S.A which will help the auto industries to manufacture more fuel efficient vehicles. Auto industries in USA should negotiate with its employee’s union to make a settlement with employee’s union to agree for wage reduction in stead of lay-off and to minimize the retirement benefits. To ensure the automobile industry resurrection, U.S government should come forward to chalk out a retirement package for employee’s of auto industry which would be equally shared by the U.S government so as to facilitate the auto industries to employ the funds so saved to enhance their manufacturing technology and to bring in more fuel efficient cars to make them compete and fit in the global automobile market. The Republicans and democrats should jointly support the above package in the nation’s interest. Their unstinted support will save the U.S automobile industry from going to grave yard. If the American government could not get the support of congress for automobile industry bailout package, it should employ the Treasury’s greater financial structure stabilization fund to bail-out U.S automobile industry provided if adequate fund is available. The U.S government should seriously think of finding out the substitute short-term financial assistance schemes to preserve its dying automobile industry. (David M Herszenhcrn, 2008). References Anthony, J, Mayo & Nohira, Notin. (2005). In their time: the greatest leaders of the twentieth century. Harvard: Harvard Business Press. Cooney Stephen, Yacobucci & Brent D. (2006). U.S. Automotive Industry: Policy Overview and Recent History. Newyork:Nova Publishers. Erbe, Bonnie. (Nov 26, 2008) We Bail out Citicorp, Why Not Bail Out GM, Too? (General Motors Corp.). U.S. News & World Report NA. General One File. Gale.  Trebilcock, M.J, Chandle, Marsha A & Howse, Robert. (1990). Trade and Transactions: A Comparative Analysis of Adjustment Policies. New York:Routledge Washington Times (July 19 2008) McCain Revs Up Auto Workers. Says Green Cars will Bring Jobs. Washington Times: Gale Publishing. Read More