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What's So Bad About Government Intervention?

As the federal government dives headlong into one of the most massive interventions into the private sector in decades - the restructuring of GM through bankruptcy, which will leave the government with a 60 percent ownership stake in the company - everyone seems convinced that government involvement is a bad thing.

Even its advocates and architects consider it only the least among evils: President Obama said, "We are acting as reluctant shareholders, because that is the only way to help GM succeed. What we are not doing -- what I have no interest in doing -- is running GM," and promised the government would "refrain from exercising its rights as a shareholder." In part this is an attempt to deflect criticism from the opposition, which is surely ecstatic to actually have something that looks vaguely like socialism to complain about; remember, they made do with much less in calling Obama a socialist during the campaign. But all appearances suggest that Obama and his entire economic team truly believe that government intervention is necessarily bad.

I know the theoretical arguments for why government intervention is bad - the profit motive is necessary to ensure efficient allocation of resources, government ownership leads to politicization of business decisions, etc. - and they make sense. But we do not live in a theoretical world, and in the real world government intervention is just one policy option among others, that should be considered on the merits.

The most common argument against intervention is that the government is bad at running companies in general, and doesn't know anything about auto companies in particular. This may be true, but it misconstrues the role of shareholders in running large companies. A large proportion of the stock of any large company such as GM is in the hands of individual investors, most of whom know little about running an auto company; the rest is in the hands of institutional investors, most of whom also know little about running an auto company. The job of the shareholders is to elect and oversee the board of directors, and their job is to select and oversee the actual management of the company. The important thing is that the managers know how to run an auto company, and that the board know enough to know if the managers are doing a good job.

In this case, the government amassed its position by lending GM more money than anyone else, and at a time when no one else would lend money. It's common practice for loans to be converted into equity in bankruptcy, and for the biggest creditor to emerge with a controlling share of the equity. What we need now is for the government to use that equity to appoint a good board of directors. If we don't feel the government is up to that task, it has a couple of options. First, it could simply decide not to vote, and let the remaining shareholders elect the board. Second, it could place its shares in a voting trust, appoint a few highly respected trustees, and charge them with voting the shares in a way that maximizes benefits to the taxpayer.

Another argument is that government intervention exposes GM to political motivations, instead of the pure profit motive. For example, Planet Money raised the idea that managing a company for anything other than profit may be illegal. In general, it's not true that a company has to be run solely according to the profit motive. If I own a company outright, I can run it any way I want. Even when a company has multiple shareholders, it is allowed to do things that have only the most tangential relationship to profitability, such as donating money to charities. However, there are cases in which a court has ruled that a majority shareholder cannot run a company while completely ignoring the profit motive, because this hurts minority shareholders.

More generally, though, the concern is that the government may seek to have GM pursue objectives that a purely profit-maximizing company would not pursue, and this will lead to inefficient outcomes. For example, the government has already promised Fiat an additional ownership slice in Chrysler if it comes out with a car that gets 40 miles per gallon. In theory, the profit motive ensures that the socially optimal amount of investment is made in various investment possibilities; if the government is providing non-market incentives for Chrysler to build a certain type of car, that's a bad thing.

Well, maybe. Market incentives ignore externalities, such as the fact that gas guzzlers are bad for society in all sorts of ways (toxic air pollutants, greenhouse gases, geopolitics, etc.). The market, on its own, will produce more gas guzzlers and fewer small cars than is socially optimal. The government is supposed to represent the public interest; if it wants to use its ownership position to influence a company to do things that are in the public interest - like building more fuel-efficient cars - then I have no problem with that.

This is not to say that there are no risks with government ownership. There is the risk of political meddling, where various politicians put pressure on companies to advance their personal interests, or the personal interests of their constituents. There is the risk that, in order to achieve political objectives (like preserving jobs), the government continues sinking money into the car companies - money that would do a better job of creating jobs elsewhere in the economy. As a result, government positions in private companies need to be managed according to clear rules and with a high degree of transparency.

But I don't think we need to accept that a role for government is evil, even a lesser evil, or that it is somehow antithetical to the proper functioning of the economy. Many people have pointed out that the current crisis demonstrates the downside of unbridled capitalism. It's surprising that so many people - all the way up to our president - persist in claiming that unbridled capitalism is nevertheless the optimal form of economic organization.

--James Kwak

By James Kwak  |  June 1, 2009; 4:13 PM ET
Categories:  Autos  
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Next: Why Not Just Take the Money?

Comments

Bravo, Kwak, between this post and the one on Baseline Scenario, you are effectively deconstructing the arguments for economic goals and what justice means. Pure economics is not a moral framework, it is about efficiency, and therefore doesn't hold all the cards.

Keep it up! I'm liking it a LOT!

Posted by: ReneeinCA | June 1, 2009 5:26 PM | Report abuse

> But I don't think we need to accept
> that a role for government is evil,
> even a lesser evil, or that it is somehow
> antithetical to the proper functioning of
> the economy

So .. could you provide some examples of companies, dates and country names, where government involvement in the companies/economy has provided superior results to that seen in the countries where "market capitalism" has been the basis for the economy?

Posted by: wmartin46 | June 1, 2009 5:45 PM | Report abuse

...and for the Republic for which it stands, one can now only reply:

SIG HEIL OBAMA!

Posted by: GordonShumway | June 1, 2009 5:53 PM | Report abuse

In response to wmartin46: "So .. could you provide some examples of companies, dates and country names, where government involvement in the companies/economy has provided superior results to that seen in the countries where "market capitalism" has been the basis for the economy?"

Japan has never has what I think you mean by "market capitalism." MITI (Ministry of International Trade and Industry), as well as the Ministry of Finance, "guided" Japanese auto companies in a variety of ways, such as heavy restrictions on the importation of American cars into the Japanese domestic market and deciding which Japanese firms would be allowed to enter the American market.

The Japanese system is often called State Capitalism, where a key goal of the government is to intervene in the market to assist private firms in being internationally competitive. I think you have to admit this has worked out pretty well for Toyota and Honda.

In all fairness, the Japanese system was always accused of trying to "pick winners." This is obviously not what's happening now with GM; picking winners would mean government support of Ford, I suppose.

Posted by: jratliff1 | June 1, 2009 5:59 PM | Report abuse

the next step is for obama to turn our Republic into the first world empire...

Posted by: DwightCollins | June 1, 2009 6:36 PM | Report abuse

Jratliff1,
Japan is our role model now? Terrific. I had thought we were trying not to fall into the crevace they have been trapped in for two decades. You seem to be advocating jumping. Yikes.

Posted by: Clio1 | June 1, 2009 6:48 PM | Report abuse

I suspect that if the Government was taking over unprofitable newspapers instead of car companies, the Post's views might change a bit.

Posted by: tomtildrum | June 1, 2009 6:56 PM | Report abuse

Mr. Kwak forgot the most important reason for the federal government not to be involved in the auto industry-there is nothing in the US Constitution that allows for this. We are truly on the way to a socialist state!

Posted by: scottbwilliams | June 1, 2009 7:00 PM | Report abuse

Most of the chat about government involvement in GM is lost in ideology and disconnected for the reality of running a large business. Government has made the choice of investing in GM at a time when the likely alternative was liquidating the company. If GM's business goes reasonably well, that decision probably will be the only major one that government makes. Of course if the viability of GM should again come into question, there will be a need for government intervention to try to protect the investment. But it is hard to see how that situation is much different from the normal case where most of the stock of a company is owned by institutional investors who have no experience in running the company's business.

Posted by: dnjake | June 1, 2009 7:00 PM | Report abuse

During the 1800s, the Tariff was one form of government "intervention", which was despised by the South, enriched the North, and brought the country to the edge of Civil War in the 1830s.

If you were a Northern factory owner, government "intervention" in the form of protective tariffs was great. But if you were a Southern farmer, they were seen to be "evil".

> The Japanese system is often called
> State Capitalism, where a key goal of
> the government is to intervene in the
> market to assist private firms in being
> internationally competitive.

http://www.fas.org/irp/world/japan/miti.htm

Ok .. Japan's governmental intervention is beneficial to Japan, but what would have been the result if the US had not been looking at a Communist takeover of Japan after WWII, and not opened its doors to Japanese products?

But MITI is different than Government Motors, don't you think?

The following NYT article is one of the reasons I think most people are not happy with Obamanizing the Auto Industry:

31-Year Old In Charge of Dismantling:
http://www.nytimes.com/2009/06/01/business/01deese.html?ref=politics


Posted by: wmartin46 | June 1, 2009 7:03 PM | Report abuse

Given the extreme failure of car-dominated capitalism - poor product, poor management, out-of control credit, greedy stockholders - and the absolute failure of archaic conservative thought and policy, Obama's move is another vital rescue mission.

Posted by: dudh | June 1, 2009 7:16 PM | Report abuse

Why Simon, nothing is wrong with government intervention, it makes things so much better!

Think of it, with the government running and deciding every little thing, the farmer would know what, how much and when to plant. He would receive a fair price for his labor.

The baker would have a stable, price guaranteed product to produce a loaf of bread, for which he would know exactly where, when and for how much he could sell it.

The consumer could go to the supermarket with out fear of encountering an unpleasant surprise as to how much that loaf of bread would cost. Since the consumers wages could be regulated they wouldn't have to worry about what to buy since that could be pre-determined by the government.

Think of it, a wonderful Utopia of satisfied consumers and producers, each certain of their place in society. I am sure you would be happy there.

Me, I think it sounds way to much like being part of the Borg, you know the enemy of man and freedom of choice. I like excitement and challenge, even when it smacks me and my bank account. I think GM should have been kicked to the curb, let the guys who know how to build good cars build them.

Truth is, Obama can try, but unless he has figured out an angle I don't know about he can't make you buy a piece of crap, no matter what he calls it. All he has done is spend you, your children's and your children's children's money for them, and left them with no choice in the matter.

The trouble is when you elect a god, he gets to make all the choices.

Posted by: kl305 | June 1, 2009 7:16 PM | Report abuse

Intervention is just another option . So is communism . So is forcing people to buy GM cars at the point of a gun . Polygamy or submitting to homosexual assault rather than fighting to the death is a choice . One should consider all options . Even if you think it goes against everything you believe in , it is just another option .

Posted by: borntoraisehogs | June 1, 2009 7:18 PM | Report abuse

Excellent article.

"Market incentives ignore externalities, such as the fact that gas guzzlers are bad for society in all sorts of ways (toxic air pollutants, greenhouse gases, geopolitics, etc.). The market, on its own, will produce more gas guzzlers and fewer small cars than is socially optimal."

"Socially optimal" not "economically optimal". This is the lie of "free-market" capitalism to begin with -- that left alone the markets truly find an optimal balance. The failure to account for externalities makes this impossible. (And if we did account for these, we'd be paying $6/gallon like they do elsewhere.)

Posted by: wdrudman | June 1, 2009 7:23 PM | Report abuse

Free-market capitalism was a nice idea in the 18th Century. And it has a simple, somewhat-understandable-to-the-masses appeal. But it doesn't reflect the world we live in accurately. It never did.

The minute you let "Invesment capital" into the mix, the markets are no longer free. We've seen the result -- excessive greed creating demand for short-term profit rather than long-term planning (reminds me of that thing Bernie Madoff ran...)

Posted by: wdrudman | June 1, 2009 7:30 PM | Report abuse

Thanks, Gordon Shumway, for your well-reasoned and intelligent commentary. Your thought provoking analysis really gets to the bottom of the issue, and enlightens all who are trying to understand the pros and cons of the administration's dealings with this financial crisis. Thank you for raising the public discourse to a level of which we can all be proud!

Posted by: tomguy1 | June 1, 2009 7:35 PM | Report abuse

> The minute you let "Invesment capital"
> into the mix

Investment capital has always been in the mix. For instance, the Virginia Colony (Jamestown, 1607) was funded by a group of wealthy investors. The plantations of the South were heavily mortgaged to British investors, even beyond the Revolution. In fact, some of the Southern states, heavily indebted in the 1830s and '40s repudiated their debt, owed to the British Bankers. This act came back to haunt them in the 1860s when they tried to borrow money from these same folks, only to be reminded that they (the repudiating States) were not such trustworthy borrowers.

Obama's repudiation of the debt owed by GM bondholders will probably haunt GM in the future.

Posted by: wmartin46 | June 1, 2009 7:41 PM | Report abuse

What about moral hazard? Every industry that employs a lot of people now has a huge incentive to wastefully invest in lobbying Congress and the president so that, if they make a lot of value-destroying decisions, they too can be bailed out. They also have an incentive to employ too many people and grant them over-generous benefits.
And I'm with scottbwilliams, there's nothing in Article 1, Section 8 of the constitution that grants the government the power to provide for the financing and management of commerce.

Posted by: neel1 | June 1, 2009 7:41 PM | Report abuse

Whats really strage? Gm inrusion by the government is totaly strange. But it is really the solution of those never understanding a government is and has to be. Those ones figthing any try tu put an enough reasonable goverment. Your are the problem nd the government you always blockked also it is.

Posted by: Vercinget333 | June 1, 2009 7:42 PM | Report abuse

You are the wrong thing about any government intervention.

Posted by: Vercinget333 | June 1, 2009 7:48 PM | Report abuse

Yes. Finally the King elects some 'better' manegers. (<Yes. How dificult to establish who are the worst managers) A risk whixh is is born because the opposition to any try to rise a real republican government.

Posted by: Vercinget333 | June 1, 2009 7:53 PM | Report abuse

There are so many problems with government involvement in private enterprise, where to begin? How about starting with the actual entrance of GM into bankruptcy, when the government intimidated the bondholders, many being pension funds and retirement plans, into taking a fraction of what was owed them. Instead, the government rewarded the UAW with a stake in the new company. Arguably, without government intervention, the UAW would have been totally broken...the UAW is at the root of the problem with GM. But the government (aka Obama) finds it ok to break contract law when it suits him and its ok to take from pensioners and investors and give to union members. These decisions are not made for the general good of the US taxpayers...they're made for specific groups that either Obama owes from his campaign days or hopes to garner votes from in the future. That's just the start of the corruption. Look at Chicago-- Obama's training ground. The corruption will get much, much worse before he's kicked out.

Posted by: antisocialist | June 1, 2009 7:54 PM | Report abuse

This country was founded on the belief that all have the right to succeed and fail in any business venture they choose to start. That is life, that is the learning curve. God gave us the brains to choose from right and wrong, have us ALL develop our talents and USE them. GM deserves to fail and they should have been able to do that last fall. They are doing NOW what they said last fall would devastate the company and the country - file for chapter 11. WHO is going to bail me out, or you???? What happens when we get sideways with our finances - WE have to tighten our belts and get OUR OWN HOUSE in order WITHOUT government intervention. So should any business, large or small, operating in America. THERE IS NO FREE LUNCH - ATLEAST FOR MOST OF US. The government has not in the past and should not now be in the business of owning companies. NO one is too large to fail, NO one is indispensible. I believed in the fall as I do now, that those companies, including the big 3 automakers, that received TARP monies, that the governing board of each and every company should have either quit, retired, or been fired and replaced with new members. You don't give "food" to the RAT with the promise of change when you know good and well that no change will take place except the wanting of more "food" - in the case with GM and Chrysler - more money.

However,Obama has declared that we the people and our money need to help these "icons?" out BUT ONLY TEMPORARY. YEAH RIGHT! When pigs fly - oooops - they are already flying!!!!

By the way - Japan and other countries DON'T have unions jerking them around and can therefo produce quality products. IN A TIMELY MANNER. These countries are totally government controlled and that's where Obama is headed IF WE LET HIM. HE WANTS ABSOLUTE CONTROL OF THIS COUNTRY AND YOU ALL DON'T GET IT!!! YOU HAD BETTER BE VERY LEERY OF WHAT HE IS GOING TO SAY IN CAIRO TO THE MUSLIMS.

Posted by: rogerjan | June 1, 2009 7:56 PM | Report abuse

The Chickens have come home to roost!

A Prophetic 1944 speech! Norman Mattoon Thomas (Nov. 20, 1884 - Dec. 19, 1968) was a leading American socialist, pacifist and six-time presidential candidate for the Socialist Party of America.

He was the grandfather of “Newsweek” columnist Evan “We are all socialists now” Thomas.

In a 1944 speech, Thomas said: “The American people will never knowingly adopt socialism. But, under the name of ’liberalism,’ they will adopt every fragment of the socialist program, until one day America will be a socialist nation without knowing how it happened. I no longer need to run as a Presidential candidate for the Socialist Party. The Democratic Party has(my insert …… and Obama have) has adopted our platform.“

Thank you, President Obama.

I did not vote for Obama during Nov. 2008.

I will not be voting for him during Nov. 2012.

Posted by: furtdw | June 1, 2009 7:59 PM | Report abuse

My firend if free market is corruption as it really is then there was onky a straight wayn to solve it. Free markey to the waste. If someone could lost their control then the Army had to show openly what the government is establishing. But it is not still the case. There are still gainig people tleking them that those leeches are still neccesary. Things what they really are which means things which we really made every day.

Posted by: Vercinget333 | June 1, 2009 8:02 PM | Report abuse

It appears to be OK to wage a war without cause on another country, resulting in the deaths of hundreds of thousands of innocent citizens. Intervention elsewhere is OK, while government intercention in our own affairs is intrusion. What a crock!

Posted by: EarlC | June 1, 2009 8:05 PM | Report abuse

Could someone, much smarter than I, please post the specific statutory basis for government (Treasury) intervention in the car companies?

My impression is that it is TARP money that has been spent, at least up until now. But my recollection is that TARP was specifically earmarked by Congress for "financial firms." That is why GMAC coverted to a bank holding company.

I know my constitutional knowledge is dated, as I am getting on, but I thought Congress had to authorize and appropriate funds expended by the Treasury.

Please help me understand this new paradigm.

Posted by: Curmudgeon10 | June 1, 2009 8:10 PM | Report abuse

Free market didn't work or at least in the behemoths that have been running us the military industrial complex, so we are really bailing out our real government. Obama was forced to clean up mess left by the real estate demons that sent us to Iraq. Hope you Republicans can grow your own vegetables

Posted by: anti1 | June 1, 2009 8:12 PM | Report abuse

Whats wrong with government intervention? Well, lets start with the government ceo, Obama, who has never held a private sector job, never met a payroll and has never produced a product - unless you count stuffed ballot boxes.

He then appoints a tax cheat to run treasury - who will have a lot to say on how things are run.

Does this sound like a recipe for success?

Posted by: VirginiaConservative | June 1, 2009 8:20 PM | Report abuse

It's doubtful that we will find any Constitutional authority for these actions, but Chris Dodd (D, CT) managed to give Wall Street some "backup" in little known legislation in 1991:

http://www.washingtonpost.com/wp-dyn/content/article/2009/05/29/AR2009052903403.html?hpid=topnews&sub=AR

Posted by: wmartin46 | June 1, 2009 8:27 PM | Report abuse

It work for the Soviets so it must work the USSA...

Posted by: whiteja55801 | June 1, 2009 8:46 PM | Report abuse

To paraphrase Churchill, the marketplace and the free enterprise system is absolutely the worst way to allocate wealth - except for all the alternatives. It is chilling to hear your statement that if the government manages a company to do things in the "public interest" that "you have no problem with it" - decides what is in the "public interest"? You? Obama? If it is deemed to be in the public interest that a certain candidate wins elective office, is it OK that a new General Motors makes political contributions to either party? You might think that question pushes the issue but at their peak government sponsored entities like Fannie Mae made huge political contributions. I respect your opinion and that you are well-intentioned, but the least bad choice in this was to let GM and Chrysler go down and let Ford pick up the pieces.

Posted by: btmryan | June 1, 2009 8:48 PM | Report abuse

What utter nonsense. No--the government REALLY is bad at running things. Look what they did to Fannie and Freddie. And what about the job the Federal Reserve did? Keep on going--how about Social Security, the U.S. Postal Service. Nearly everything the government touches sucks cash and breeds like a blood engorged fly.

Posted by: jchenn | June 1, 2009 8:58 PM | Report abuse

Terrible thought process here. It boils down to this:

"The Government loaned GM a lot of money and now we've got to take it over or we'll lose all that money".

That's it. That's the whole argument.

So let's deconstruct that argument:

1) If that's the case, they why did the government loan GM the money to begin with? They could have let it declare chapter 11, let a court reorganize and they'd be on their way.

2) Obama's team isn't stupid and they know this.

3) Thus loaning GM $20B was essentially the pretext for massing government involvement in bankruptcy

4) Why? Doesn't make sense!

5) Partially as a payback to the UAW, partially because politically, letting GM declare bankruptcy all by itself would make Obama look bad with his core constituency.

6) Plus, they really do have visions of telling GM the "right" thing to do. GM, you must build greener cars! It's an eviro-kook's wet dream.

7) More proof... GM's assets are about $80B, their debt is about $170B. In that kind of circumstance, why would anybody loan them money. You'd have a better chance of getting your money back if you threw $20's out of an airplane into Southwest.

8) Prediction: Dem's in congress will try to steer GM to make "greener" cars, but will refuse to cut the unionized workforce and we'll all end up subsidizing every GM car until a sensible person is back in office and just cuts GM loose.

9) Nobody wants to face up to the idea that GM's labor costs are too high and that is laid directly at the feet of the UAW membership. You fix that "little" problem and magically GM will recover all on it's own.

Posted by: Ombudsman1 | June 1, 2009 9:00 PM | Report abuse

Let's see. Total bail out funds for bank, et.al. so far is 1.3 Trillion. 30 billion to GM is chump change. Why didn't we just advance them that to start with? We should all be rolling in dough by now.

Last headline I saw in USA today said that I now owe another $55,000 for this year's spending alone. Wonderful. That over half my total income. I'm supposed to live on rice and beans. Let's see the Gov't do that.

Posted by: ssmorehouse | June 1, 2009 9:22 PM | Report abuse

Per
"...and for the Republic for which it stands, one can now only reply:

SIG HEIL OBAMA!"
as is usual of your type ZERO DEBATED ISSUE; 100% IMMATURE CHARACTER DEMONIZING.

Grow up. Trying issues and ideas.

Posted by: Bushlegacylies | June 1, 2009 10:01 PM | Report abuse

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