Bailouts

For a baby boomer who grew up in the Midwest it is odd that questioning Mitt Romney about how generous he would have been with taxpayer help for General Motors is considered a winning issue for Democrats.  General Motors was the number one company in America for 22 of the first 25 years of the Fortune 500 list of the largest companies in America.  The only three years that General Motors was not number one was in the early 1970’s when gasoline prices spiked and GM ranked second to Exxon.  A Federal bailout of General Motors was as unthinkable in 1980 as it is today to imagine a presidential campaign in 2052 in which candidates argue about how much taxpayer money should have been used to bail out Apple or Google.

General Motors and successful tech firms in Silicon Valley have (or in the case of GM had) an advantage over their competitors based on their size and geographic location.  The important work of Paul Krugman, and others, explained that companies and countries can have an advantage over their rivals based on increasing returns and geographic concentration.  Google, Apple, Facebook and other tech firms in Silicon Valley have an advantage because of the available supply of engineers, software developers and programmers which lowers the cost of hiring and turnover.  For General Motors and other automakers in Michigan and Ohio, the advantage came from a location near parts suppliers and the suppliers of other intermediate goods and raw materials.

Krugman’s work explained that firms benefit when they are located near similar producers.  This is true for automakers in Detroit and tech firms in Silicon Valley.  When automakers in Detroit or tech firms in Silicon Valley fail the market test they have done so despite their advantages over competitors in other areas.  The bailout of financial institutions was based on a notion of “too big to fail.”  The systemic risks of allowing a large financial institution to fail were perceived to be too high; there would have been too much collateral damage.  The rationale for bailing out manufacturing firms advantaged by their size and proximity to key suppliers and human capital is much more sketchy.  It establishes a dangerous precedent for future recessions when other large American companies, who faced advantages similar to those enjoyed by GM, will also file for bankruptcy.

The Motor City Needs a New Nickname

Detroit has been called the Motor City for almost a century, but that nickname no longer applies. In 1973 the Big Three automakers had a market share of over 80%, and more than one out of every four workers in the motor vehicle (and parts) manufacturing industry was employed in the Detroit metro area. Today, fewer than one in nine autoworkers are employed in Detroit, even after Federal assistance was provided to two domestic automakers.

The Obama Administration is proposing policies to help “insource” manufacturing jobs back to the US. The case of Detroit tells us that both new and existing manufacturing jobs are likely to re-locate in states with lower taxes and right-to-work laws.

The past 38 years has seen many changes in the auto industry, but the most striking change may be where vehicles are produced in the US. Auto industry employment declined by 70% since 1973 in Detroit, but increased in states outside of Michigan and Ohio.

Forty years ago economists might have argued that Michigan and Ohio had a comparative advantage in motor vehicle production. Factories in the upper Midwest were located close to suppliers of parts and raw materials and had access to the infrastructure that facilitates vehicle shipments. As the fortunes of the Big Three waned, foreign-owned firms had access to a pool of laid off workers with valuable skills and experience.

Nonetheless, in the past three decades new motor vehicle production facilities were built in cities and states that had none of the incumbent advantages of Detroit and Michigan. Foreign-owned firms were instead attracted by the lower taxes and more favorable labor laws in Southern states. I suspect that if manufacturing jobs are “insourced” back to the US in this economic recovery, Southern states will again be the beneficiaries.

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