Posted by: bmeverett | November 10, 2008

Dr. House and the auto company bailout


The best program on TV today is without doubt House. For the reclusive few who have never seen this brilliant series, it’s a formula show where every episode has the same plot. A patient appears at the hospital with bizarre and obviously serious symptoms, usually involving strokes, seizures, extensive bleeding and organ failure. Death is imminent. Dr. Greg House’s colleagues on the diagnostic medicine team are smart, warm-hearted, caring, polite and well-groomed. They are deeply concerned with the patient, but misdiagnose the problem, ordering treatments that undoubtedly make the patient worse. At just about 45 minutes into the show, Dr. House, who is a mean-spirited, sarcastic, unkempt curmudgeon addicted to pain killers, has a sudden epiphany, finally diagnosing the problem correctly and promptly curing the patient. (House doesn’t actually care about the patients; he just finds the medical puzzles intellectually interesting.)

The show has a simple moral: in the world of medicine, proper diagnosis trumps caring (and good grooming). The same principle should apply in the world of economic policy, but, alas, it does not. General Motors has been rushed to the Capitol Hill Emergency Room with severe hemorrhaging (cash, not blood), fatigue, anxiety, and depression. His family (also known as the State of Michigan) will starve unless his life can be saved.

There’s no question that GM is really sick. Reported losses over the last four years have totaled nearly $70 billion, and the share price has fallen from $55 per share to under $5. GM by its own admission is bleeding $2 billion per month and may exsanguinate by the middle of 2009.

Enter the brilliant, suave and oh-so-caring Dr. Obama. In May of 2007, Dr. Obama offered his diagnosis of our automotive illness in a speech to the Detroit Economic Club. The problem, he says is that “For years, while foreign competitors were investing in more fuel-efficient technology for their vehicles, American automakers were spending their time investing in bigger, faster cars. ….. While our fuel standards haven’t moved from 27.5 miles per gallon in two decades [Note: This has now changed with the 2008 standards requiring 35 mpg], both China and Japan have surpassed us, with Japanese cars now getting an average of 45 miles to the gallon.” The proper treatment is public funds for “retooling” factories to produce smaller cars and hybrids. Is this a good diagnosis?

As any good doctor would say, “Let’s run some tests.” If Obama’s assessment is correct, we’d expect Chevrolet dealerships to be stocked with large cars, vans and SUVs, gathering dust while demoralized salesmen waited for customers who never came. It’s certainly true that the Chevy dealer has lots of big vehicles, including the Suburban SUV (curb weight of 5,600 pounds, 16 mpg) and the Silverado pick-up truck (5,700 lbs, 14 mpg), but you’d also find the mid-size Malibu (3,415 lbs, 26 mpg), the Cobalt (2,747 lbs, 25 mpg) and the Aveo (2,531 lbs, 27 mpg).

Now let’s walk across the street to the Japanese automakers. According to Obama, we would expect to find a fleet of the gas-sipping small cars and hybrids that consumers really crave. Toyota has its flagship Prius hybrid (2,932 lbs, 46 mpg) and its subcompact Corolla (2,595 lbs, 31 mpg) – both very efficient. But Toyota’s best seller is the mid-size Camry (3,307 lbs, 25 mpg). If you want, you can also buy a full-size Avalon (3,495 lbs, 23 mpg) or a Land Cruiser SUV (5,425 lbs, 13 mpg). In its relentless drive for a fuel-efficient fleet, Toyota’s most recent offerings include the Sequoia SUV (5,100 lbs, 15 mpg) introduced in 2001 and the Tundra pick-up (5,330 lbs, 16 mpg) introduced in 2000.

Obama seems to have misread the x-ray, confusing the high fuel economy of the cars sold in the Japanese market with the cars Japanese companies sell in the US market.

We can run a second test. With gasoline prices still hovering around $3.00 per gallon, what are Americans actually buying? In October, 2008, car sales were down across the board, but the ten best-selling vehicles in the US were:

1. Ford F-150 (pickup)

2. Chevrolet Silverado (pick-up)

3. Toyota Camry (mid-size)

4. Toyota Corolla (subcompact)

5. Chevrolet Impala (mid-size)

6. Honda Accord (mid-size)

7. Honda Civic (sub-compact)

8. Nissan Altima (mid-size)

9. Dodge RAM (pick-up)

10. Honda CRV(SUV).

US car companies make 3 of the top-five models and 4 of the top ten. Nothing in this sales pattern suggests that American car companies are making the wrong types of cars. Dr. Obama thinks that GM’s salvation lies in making the cars that politicians want consumers to have rather than the cars consumers actually want.

Obama also seems to confuse “cars produced in the US” with “cars produced by US companies.” Many Fords, for example, are produced in Mexico, while many Toyotas and Hondas are produced in the US by American workers.

OK, it’s 45 minutes into the show, so what’s the real diagnosis from the uncaring Dr. House? He concludes that GM suffers from two self-inflicted wounds. The first is its history of bad deals with the unions. GM has taken unconscionable risks in promising overly generous pensions and health benefits not only to its employees, but also to its retirees. According to the Detroit News, Ford pays about $1,000 in health care costs for every vehicle it produces, while GM pays nearly $2,000. Its competitors were much more prudent in their labor arrangements.

The second wound is the complacency of the 1970s that cost American car companies their brand image. It’s true that the Japanese entered the American market in the 1970s with small cars. After all, that was what they produced in Japan. Their timing was lucky, since the Japanese move came right when gasoline prices spiked in the US, and Americans for the first time began to worry about gasoline supplies.

Detroit recognized the need for new models, but many of their early attempts at small, fuel efficient passenger cars were absolute disasters. Take, for example, the Chevrolet Chevette, introduced in 1976. Tom and Ray Magliozzi of National Public Radio’s “Car Talk” called the Chevette the “fifth worst car of the millennium.” One listener described his Chevette as “an engine surrounded by four pieces of drywall.” Several of Detroit’s other rushed-to-market small cars also made Car Talk’s “worst car” list, including the Ford Pinto, Chevrolet Vega and American Motors Gremlin.

Since that time, Detroit has been playing catch-up on quality. Although the US companies have made considerable progress, they haven’t quite closed the gap. Once lost, brand value can’t be easily recovered.

If Dr. Obama follows through with his treatment plan of public funding for GM, we’ll keep pumping blood into a patient who will continue to bleed through his multiple open wounds. This treatment will keep the patient unconscious and on life support indefinitely. Not a very good outcome.

Dr. House would likely conclude that unless GM can stop the bleeding by fundamentally restructuring its labor contracts, it will die. If the United Auto Workers won’t cooperate in this restructuring, they will die too. The State of Michigan will have to go out and get another job. Harsh, perhaps, but that’s life.

Second, GM needs to have its dead limbs amputated. Hummer should be the first to go, followed quickly by Buick and many Chevrolet, Pontiac and GMC models. The GMAC banking arm has lost $8 billion over the last year and is probably dead as well. Saturn may survive. The GM that emerges will be a dramatically smaller company with much lower employment, but at least some competitive role to play in the industry. If GM refuses the treatment, pull the plug. Cause of death: suicide.

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Responses

  1. Greg Mankiw has a great graph comparing per hour compensation rates between Japanese and Detroit auto employees. Enlightening!

    http://gregmankiw.blogspot.com/2008/11/cost-differences.html

    …and nevertheless people like Tom Friedman will argue endlessly that GM’s woes are becasue of pushing gas guzzlers and spending money on lobbying.


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