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Now An Owner, Government Must Act Like Long-Term Investor in GM, Chrysler

Case Western University economics professor Susan Helper and Michigan Manufacturing Technology Center research director Daniel Luria filed this guest blog post:

The U.S. Treasury – and therefore the American public – has become a co-owner of General Motors and Chrysler. The billions in loans made to these entities will soon total at least a decade’s profits, and they won’t be paid back anytime soon. So it’s time for the federal government to think like a long-term investor rather than a desperate bailer-outer.

What returns should Treasury seek on our collective behalf? The government might seek to maximize long-term tax revenues; retain high-wage jobs; promote environmental goals; or retain critical capabilities in a strategic industry. The importance of auto companies and their suppliers as employers has already been explicitly recognized in the Bush and Obama administrations’ decision to provide “bridge loans.” The goal of the bailout was to avoid an employment implosion, not to ensure shareholders’ returns.

Yet the main thrust of the Automotive Task Force has been to require GM and Chrysler to do precisely what a profit-only-focused hedge fund would do: shrink capacity, and therefore employment, to get costs below revenues. The plans that GM and Chrysler submitted in March were certainly unrealistic and inadequate. But the problem was not that those plans didn’t plot out a sufficiently draconian capacity shrinkage; rather, that they failed to demonstrate a path that would lead to a return on the public’s investment—on any of the metrics above.

Given that the public will own these companies for a while, and given that its interests are different from private owners’, how should we manage them? Managers who seek to make good decisions on the public investor’s behalf owe it to themselves to get answers to some important questions. Let us offer some examples.

Beyond the implosion in the market for all new cars and light trucks, why are GM and Chrysler less competitive than Toyota and Honda? Cost is a small part of the answer: With a younger workforce, the Japan-based automakers have lower health care costs, for example. But that’s temporary, because their workforces, too, will age.

Neither wage rates nor labor-hours-per-vehicle are meaningfully different across the four companies. The real difference is that Toyota and Honda are able to get consumers to pay more for each unit in nearly all segments.

Why? Because many consumers perceive their vehicles to be worth more. That perception even extends to used Toyotas and Hondas as well: Not only does a Toyota Camry sell for about $2,000 more than a comparably-equipped Detroit vehicle; Kelly Blue Book and Edmunds both report that it’s worth thousands more after four years. The perception of greater value thus results in a product that, while more expensive to buy and therefore more profitable to sell, is also cheaper to own.

Why are Toyotas and Hondas perceived as more valuable? With detailed answers to this question (for example: are low quality ratings due to failing electronic control modules or squeaks due to cracked suspension bushings?), management could systematically address quality, durability, and drivability deficits. Over time, doing this will cause customer perceptions to change.

While the Detroit automakers can point to a handful of projects that zero in on the causes of defects, and while they regularly tear down competitors’ vehicles to see how they’re made, they don’t consistently act on what they learn because it costs “too much.” A hedge fund with a two-year time horizon for flipping the assets can accept this answer; indeed, it might rationally insist on it.

This short-term thinking explains why the automakers are in such trouble now. They chose to spend the profits of the 1990s buying back their stock while investing only minimally in the quality systems needed to compete with Toyota. (Indeed, research by Prof. William Lazonick shows that, had GM invested the $20 billion it spent on stock buybacks between1986-2002 at 2.5 percent, it would now have $34 billion, and not need to be borrowing from the public.)

While this strategy may be rational for shareholders, it is not rational given the public’s broader goals. Allowing quality deficits to persist that encourage low consumer valuation of their products will inevitably result in less domestic income. This difference in goals explains why GM and Chrysler might be able to become competitive under public ownership when they couldn’t under private.

These broader goals should also inform how public investors assess whether GM and Chrysler should get more of their vehicles and parts from Mexico and low-wage Asia. Are the savings from doing so large enough to offset the decline in domestic income and capabilities it causes? One view holds that off-shoring is an efficient way to cut costs, thus showing careful stewardship of taxpayers' money.

Another view is that offshoring often has large hidden costs. For example, offshoring may allow quality problems to fester because of difficulties in communication across borders and language barriers. Offshoring may also cause a loss of critical capabilities in the supply chain and undermine efforts to build a high-wage economy.

Without detailed studies of the true costs of sourcing individual components, government-appointed Board members can’t act in the public’s interest. In this regard, it seems bizarre that the Automotive Task Force strongly prefers a future fleet that is more fuel-efficient, yet expresses no preference about where its parts should be made. In our view, the government should pursue the public’s interests on both points.

Management that seeks to make good decisions on the public investor’s behalf owe it to themselves and those they represent to have a clear vision of what its goals are. In particular, the public’s status as a long-term investor creates an urgent need for its managers to adopt policies that promote the long-term health of the auto industry. To do this, they need to sponsor—and act on-- fact-based research into the real issues.

--Susan Helper is an economics professor at Case Western Reserve University. Daniel Luria is research director of the Michigan Manufacturing Technology Center.

By Sara Goo  |  May 15, 2009; 6:00 AM ET
Categories:  Autos  
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Is it possible that the blog mentality is the problem. There is no ownership and this article/blog has none. These folks don't live or die based on a blog, but folks livelihoods are threatened by the blogger mentality.

Posted by: robinhood2 | May 15, 2009 8:00 AM | Report abuse

The authors make it sound as if the "perceived" as opposed to real quality differences between Detroit and Asian car makers is a new matter that should be investigated.

The authors obviously have no knowledge of the system of constant improvement which is a hallmark of Toyota, Honda, etc. They should read the later David Halberstam book The Reckoning, which was written over 20 years ago and is still relevant. It compares and contrasts Ford and Nissan. While Detroit has gotten better in many areas, so has Tokyo. I doubt that the federal government can do any better. In fact, politics and the unlimited Treasury funding will mask deterioration. The British government used to be in the car business. Does anyone remember British Leyland? Probably not, and for good reason.

Posted by: hmgcpa52 | May 15, 2009 8:12 AM | Report abuse

omg, the gov will try to make a better product then Toyota and Honda ?. We should all be very afraid for our tax dollars.these are the same clowns that in July 2008(Barney Frank) who told us Fnma and Freddie Mac were "sound" companies. Kim Ill Jung just invalidated all contracts with South Korea in a series of Joint ventures established a number of years ago. North Korea has decided to establish "new" wages and regulations for these joint ventures. South Korea can accept the new rules or "leave". Not much diff then what the Obama administration is doing. This is not the way to do business and make $'s for the taxpayers. It is a joke to think Obama and his socialist agenda to save the Unions will lead anywhere except into a taxpayer abyss of wasted $'s and time. The gov make a better product then Toyota , Honda ? Ha Ha, to investors , sell all the GM and Chrysler share you can, they will be worth even less a year from now.

Posted by: snapplecat07 | May 15, 2009 8:23 AM | Report abuse

Everyone - you are jumping to the wrong conclusion - what the authors are saying is that the government is pursuing a Wall Street-type model for GM and Chrysler which has already failed. They are arguing that the Feds have a chance to push the companies to be more like the Japanese, but they are blowing that chance because of their Wall Street backgrounds.

Posted by: gearhead2 | May 15, 2009 10:42 AM | Report abuse

If only the Soviet Union had economists as smart as these, they could have had a world-class automobile industry. Obviously.

Posted by: _Nemo_ | May 15, 2009 1:22 PM | Report abuse

From today's Dallas Morning News:

" Will Churchill, co-owner of Frank Kent Dodge [Fort Worth], said his family bought the dealership 18 months ago at Chrysler's urging and paved six acres last winter so it could buy additional vehicles from Dodge and help keep the automaker's factories open.

"We did not even have a contingency plan," said Churchill, who assured his 40 employees Thursday that the family will find work for them at other dealerships. "We feel betrayed."

He estimated that the family has more than $3 million invested in the dealership."

Yet, in its bankruptcy declarations, Chrysler's management says they have planned on closing these dealerships for many years. To me, it sounds like the individual human beings who are senior Chrysler management employees have conspired to defraud people, like the Fort Worth dealer above, into buying and expanding a dealership, and purchasing massive inventory. Sounds like criminal fraud warranting prosecution. Hang 'em Texas.

Posted by: Jennifer555 | May 15, 2009 1:54 PM | Report abuse

I own a 2008 Buick Lucerne. I just rented a 2008 Nisson Maxima for vacation. Per the rental company both of these vehicles are Premium vehicles. The Nisson had cheap door and dash materials, stiff stearing, driveline vibration and grabby brakes. It was obviously an inferior product compared to the Buick. It is tiresome to see the imports get overgraded and GM get undergraded on car quality and value. I don't understand this skew of reality.

Posted by: keith553 | May 15, 2009 2:07 PM | Report abuse

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