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Saturday, November 28, 2009

GM: Bailout or Bust?

This post has little to do with health care--well actually it does if you consider the ramifications of GM failing and not funding it's health care obligations to thousands of retirees--however, I feel it is an important issue when considered in a historical context of the automobile and GM in America over the last 100 years.

This is a paper that I wrote with the help of some of my classmates in our MBA class on economics for managers.


We have been asked to consider whether General Motors should have been ‘bailed out’ by the American tax-payer or whether it should have been allowed to suffer the economic consequences imposed by a free-market system on any other company or enterprise that cannot produce or compete efficiently in a competitive market. Unfortunately, we are tasked with this assignment after-the-fact that the “bailout” has occurred and—of course, being a very recent development—there has not been enough time transpired or historical evidence accumulated to argue the point one way or the other. Therefore, we are left with the task of retrospectively and hypothetically arguing the positions using the economic principles taught to us from our course in micro and macroeconomics.

Now most economists, students of economy, and free-market ideologues would (or should) rightly argue that in a truly capitalistic and free-market economy, it is the forces of the market that should dictate those firms that survive and those firms that do not survive based solely on their ability to produce and compete efficiently in the market. However, the birth and death of firms in the market—unlike the birth and death of stars—does not happen in a vacuum and there are other and compelling factors to consider including political, national, social, cultural, historical, philosophical, and even emotional factors when trying to decide whether we let a firm like General Motors die or survive. Like the social and cultural conundrums of abortion and the death penalty, there is not a black or white or right or wrong answer that can or will be agreed upon—regardless of the ultimate outcome.

Before we lay out the arguments both for and against the ‘bailout’ of General Motors, we must fill in the vacuum and provide a backdrop or context within which we can effectively and pragmatically present, analyze, and discuss the arguments and evidence for and against the ‘bailout’. What follows are two brief discussions on the impact of the automobile in the 20th century and a brief history of the automotive industry in America and General Motors.

The Automobile and the 20th Century

Of all the revolutionary inventions and innovations of the last century, it can safely be argued that it is the automobile that has had the most profound effect in shaping western society in general and American society in particular.

It was the automobile that facilitated the emergence of American suburbia as it allowed workers and their families to live further away from the congested urban cities that they worked in. It also allowed those that lived in rural areas much easier access to goods and services and other creature comforts that were only available in the larger towns and cities. The automobile allowed for much greater mobility and made America and the world smaller. This allowed for greater commerce and opportunity which increased the standard of living for all and especially for those that were directly involved in the automotive industry. Indeed, it can be argued that the automotive industry—primarily GM, Ford, and Chrysler—created an entire relatively prosperous middle class, especially in the Midwest, from workers and people that otherwise would have never had such an opportunity considering their education level and class status.

Apart from the greater mobility and commerce that the automobile allowed, it also spawned or facilitated a variety of other and no less important developments and related industries including, parts, paint, and tire manufacturing, parts retailers, dealerships, road building and maintenance, an interstate highway system, gas and service stations, auto racing, and even drive-up and drive-through eating establishments.

The automobile not only radically changed the way we lived, but it also altered the way we fought wars with the introduction of mechanized infantry and tanks and the ability to transport troops and supplies quickly and in much greater quantities. The automobile allowed for the more rapid transport of the injured and sick to hospitals, but conversely also introduced more severe injuries and deaths and in much greater quantities.

Finally, apart from the direct effects and consequences of the automobile in shaping our world, there have been innumerable indirect benefits—and consequences—derived from the automotive industry including technological spin-offs from research and development and pollution. One cannot talk about the automobile without talking about advances in materials and materials science, propulsion systems, petroleum science, engineering, manufacturing processes, environmental sciences, and even advances in medicine and surgery through the improved understanding and treatment of trauma. Indeed, one could even argue that were it not for the automobile, the other two revolutionary inventions and innovations of the twentieth century that have radically changed the world to make it even smaller—air travel and the internet—could have never been developed.

Today, every American enjoys an affluence and position—and some would include freedom— in the world that would have never been possible without the introduction of the automobile and it’s far reaching and long lasting effects on our society. Indeed, some have even made the cogent argument that were it not for the automobile and its related industries, technological spin-offs, and the production capacity of our automotive industry, we could have possibly lost WWII.

A Brief History of GM and America’s Relationship with the Automobile

In the introduction above we have outlined the impact of the automobile on the 20th century and in particular, how the automobile has shaped American society and culture. From early horseless carriages in the late 1800s to the 57 “Chevys” and “T-Birds” in American Graffiti to sleek “Caddys” and fast pony cars (Camaros and Mustangs) in the 70s and 80s to big Suburban SUVs in the 90s all the way to Martian land-rovers and futuristic Camaro-Transformers, nothing has captured the attention of the American people or has defined our culture like the American automobile.

Americans have always loved their cars and the American automobile has been a symbol of freedom and affluence for most of the last 100 years, not only in America, but also abroad and one cannot talk about the American automobile without talking about “the Big Three” or General Motors, Ford, and Chrysler. Out of the several hundred car manufacturers in the early 20th century, it was these three that survived to become the predominant “car makers” in the United States for most of the century. Indeed, General Motors dominated the world market and was the largest car manufacturer in the world until very recently and held that position from 1931 to 2007.

In 1896 the Duryea brothers and their Duryea Motor Wagon Company sold 13 cars and from 1901 to 1904 Ransome Olds and his Olds Motor Company sold hundreds of Oldsmobiles. By 1927 Henry Ford had produced and sold 15 million Model Ts and was producing 60% of America’s cars. General Motors was formed in 1908 by William Durant and Pierre DuPont as a holding company for Buick and by 1909 he had acquired several car companies including Oldsmobile, Cadillac and a truck company that would later become GMC Trucks. In 1910 Durant lost control of his company (General Motors Company) and a few years later started another car company called Chevrolet. Through Chevrolet, he was able to wrest control of his old company and reorganize it as the General Motors Corporation. Not long after, he again lost control for good as a result of a crash in the market for new vehicles (sound familiar?). After the exit of Durant, Alfred P. Sloan took over and led GM into its postwar global dominance.

While Henry Ford is credited as being the “father of the American automotive industry” with his revolutionary design, low prices, and production innovations, it was Durant and his General Motors Company that quickly surpassed the Ford Motor Company with successful marketing and by offering the consumer variety not only in models, but changes from year to year within models.

Sloan is credited as being the ‘genius’ behind the success of GM through his marketing and management structure innovations which brought huge success to the company through most of its existence, but which would prove to become unwieldy and ultimately lead to the eventual collapse of one of the largest corporations in the world. Consider that in 2008 General Motors was selling 9 million automobiles a year globally in over 120 countries and by 2009 General Motors was broke.

By 2008 General Motors, Ford, and Chrysler were feeling the impact of the greater economic recession and the precipitous drop in demand for cars, compounded by intense competition from Toyota, Nissan, and Honda (the Big Asian three) and volatile gas prices. In October of 2008, the “Big Three” were asking for loans from the government and in June of 2009 GM was forced into reorganization through Chapter 11.

Before we leave the history of the automobile in America and present the arguments for and against the ‘bailout’ of General Motors, we must briefly discuss the history of the United Auto Workers or UAW which is inextricably tied—for better or for worse—to the history of the automobile industry and the history of the “Big Three” automakers.

The UAW was founded in 1935 in Detroit, Michigan under the American Federation of Labor and was one of the first labor unions to organize African-American workers. In December of 1936 the UAW staged a sit-down strike at GM’s Flint, Michigan plant which was not settled until February of 1937 and which had become violent with the strikers and their families taking over the plant and resisting attempts by the police and other officials to evict them. GM was chosen as a target for a strike because it was the largest employer of auto workers at the time. The settlement of the strike and the recognition of the UAW by GM instantly boosted the legitimacy, prestige, and power of the UAW which they would continue to leverage and hold to the present day. The BBC would later comment that the strike at Flint “was the strike heard around the world”. A month later Chrysler recognized the UAW and it was not until 1941 that Ford finally recognized them. UAW membership went from less than 30,000 before the strike at Flint to over 500,000 the following year and in the 70s boasted membership of close to 2 million. Today the UAW has about 480,000 members and is still capable of bringing the auto industry to its knees.

America Should Have ‘Bailed Out’ GM

Since GM and the other two motor companies came to Washington pleading for money last year, there has been raging and acrimonious debate in the media, on the internet, in political circles, in academic circles, in business circles, and in private homes regarding whether we should have bailed out the car companies or not. While some of the arguments are based solely on the strict application of economic principles, much of the argument has become mired in or based on political and philosophical ideology which has complicated the argument both ways. Also complicating the debate is the fact that—as goes in most socio-political debate—data and evidence, even from the same exact source, are routinely taken out of context, spun, and presented as statistical and economical evidence both for and against the proposition!

Arguments for the ‘bailout’ have primarily centered on the expectation of a ‘doomsday scenario’ with catastrophic economic losses and further risks to the economy and other social and political costs associated with the failure of GM and the failure triggering a downward spiral or domino effect on other companies and industries. Those arguments generally fall into four broad categories and include economic arguments, technology and trade advantage arguments, national security and socio-political arguments, and national pride arguments.

Many proponents for the ‘bailout’ argue an economic rationale and point to the risk and costs of a large and rapid influx of unemployed auto workers and other workers from associated industries such as dealerships and parts manufacturers and suppliers into the already large and growing unemployment rolls. They cite the potential loss of 128,000 jobs alone from GM if it were to fail and up to 3 million jobs in a worst case scenario of a domino effect causing the failure of the other two domestic car makers and associated companies and industries. They also point to the fact that a failed GM could cause tens of thousands of retired employees to lose their pension plans and health benefits with additional disastrous results on an already burdened economy and health care system.

Other ‘bailout’ proponents argue that allowing GM to fail could result in the potential loss of sensitive and critical technology and associated comparative advantage in those areas to foreign firms and governments which could also pose potential serious consequences in matters of national security. They argue that throughout our history, ground-breaking technology has evolved from research and development in the domestic automotive industry which has been used in other industries, including national defense. They point to the fact that GM developed the technology for its On-Star navigation system which is being used by our military and is currently developing critical technology in lithium-ion batteries and other alternative propulsion systems. It is not too farfetched, they add, to see that while currently, we may be engaging in friendly competition with our foreign competitors and even some sharing of ideas and technology within a global market, a change in the geo-political winds could easily turn competitors into enemies that could use our own technology against us—industrially, economically, and militarily.

Next, there are those that would argue from a socio-political standpoint that allowing GM to fail would result in the exportation of a large portion of our manufacturing base overseas leaving us dependent on foreign firms and governments for manufactured goods and associated technology—again with a real risk to our national security. They argue that our economy is dependent on a solid manufacturing base and that if we lose GM we will have come dangerously close to becoming a nation of consumers in an economy based on service industries and financial services only while depending on other nations to produce for us—and we have all recently experienced what happens when we rely on financial markets as a source of our economic well-being.

Finally, there are many of us that would argue that, if for no other reason—GM should not be allowed to fail as a matter of national pride, national identity, and national integrity. GM, good, bad, or indifferent is an American icon and has served as a symbol of American prosperity, ingenuity, freedom, and ‘good-old Yankee’ industriousness for the last 100 years. GM, along with Chrysler and Ford are responsible for at least two to three generations of a middle-class in America that never would have gained such prosperity without them. Furthermore, they argue that it was the large production capacity and the technology developed by these companies that helped us win World War II and maintain our prominence on the world stage as the world’s industrial leader.

These three companies have donated hundreds of millions if not billions to American charities and other causes. They have educated and trained thousands of bright young American women and men in engineering, business, and the automotive trades. In 1953, during his senate confirmation hearings[1], General Motors CEO Charles Wilson said “what is good for the country is good for General Motors and what is good for General Motors is good for the country”. Those words ring as true today as they did in 1953. So, if for no other reason—we owe it to them!

America Should Not Have ‘Bailed Out’ GM

There are many free-market ideologues including economists and some politicians and many many angry Americans that feel that we should not have bailed out GM from its dire straits. For the economists and the free-market ideologues, this argument is rather straight forward and based on sound economic principles defined by competitive free markets. It is an emotionless and pragmatic argument based solely on economic rationale without consideration of other social or political costs or consequences. The principle argument is that it is the ‘invisible hand’ of the free market that determines who competes and who doesn’t compete and if GM or any other firm has not been adaptable or flexible enough to remain efficient and competitive, then so be it.

The argument continues with the practical reasoning that as the ‘invisible hand’ determines who competes and who doesn’t compete, it also magically and mysteriously ‘picks up the pieces’ when firms and industries fail or become obsolete as the factors of production move on to other firms and industries and the households change their tastes and demand to accommodate the change and vice versa.

On the other hand are those that are just plain angry and frustrated with our current economic situation and use the argument that we are just tired of doling out our hard earned money to failing enterprises, especially if they are failing because of incompetence or greed or both. Many of these are of a younger generation and have grown up in a relatively stable and prosperous era where globalization is the norm and they are more likely than not to drive a Toyota, a Honda, a BMW, or some other foreign car which to them has been associated with higher quality and higher value. The loss of GM, or Chrysler or Ford means nothing to them—they don’t drive or buy their cars and besides, they wonder—“what have the “Big three” done for me?”

Both of these camps argue that $50 billion dollars is a ridiculous amount of money to pay for a company with a net worth of $-90 billion dollars and that in all likelihood will never pay all of its debt and that that money could better be used for other purposes such as paying for extended unemployment benefits, retraining displaced workers, and investing in other emerging industries that will eventually hire the displaced workers. Many of them also argue that the government has no business in buying and running failing companies just as a matter of mistrust in the government meddling in what otherwise is considered private enterprise.

The opponents of the ‘bailout’ also argue that GM has not been able remain competitive because of corporate arrogance resulting in corporate mismanagement in labor relations, organizational structure, quality control, and production efficiency and costs. They argue that if Toyota or BMW can build a better and cheaper mousetrap, then c’est la vie.


As we noted in our introduction, what we have presented so far has been an ‘after-the-fact’ and hypothetical analysis of the proposition of whether GM should be bailed out or not as if the ‘bailout’ and eventual bankruptcy had not happened. We presented both arguments for and against the ‘bailout’ within a general historical context of the automobile, the automotive industry, and GM over the last century. Of course, the ‘bailout’ has occurred and only the passage of time or history will tell us whether the bailout was a good idea or a bad idea.

Today, all we can do is wait and see what will happen. We have provided compelling arguments both for and against the ‘bailout’ and we can only offer conjecture as to why our government decided for the bailout, but we can look at what has happened to date and offer our analysis, based on the arguments presented above and leave the final decision to each of you.

It is clear to all of us, whether for or against the ‘bailout’, that GM and the other two domestic automakers have made some serious, if not catastrophic miscalculations with respect to their relative positions in their market and have critically, if not foolishly, underestimated their competition. But given this, we also realize that the economic events of the last two years have been anything but typical and have caught us all by surprise—as individuals, as households, as firms and even as a government.

Was this failure of the domestic automotive industry an inevitable outcome after years of corporate mismanagement, poor judgment, and reckless optimism—or was it more likely that a ‘perfect storm’ of economic calamity fueled by individual mismanagement, poor judgment, and reckless optimism, a volatile gas market, and poor government oversight (or more likely, government blindness), that battered the otherwise viable, but marginally competitive ‘Big Three”? We cannot know the answer to that, but the question does offer insight into why we bailed out GM.

While, all of us can acknowledge that foreign automakers have made tremendous strides and significant advances in the automotive industry, especially in the latter half of the 20th century and the beginning of this century, no one can dispute the fact that American automakers have reigned supreme throughout the world for the last 100 years with respect to innovations and contributions to industrial society in general and American society in particular.

Allowing GM to fail with the very real possibility of the entire domestic automotive industry following suit in an uncontrolled chain reaction would effectively represent the national capitulation of our dominance held for over 100 years to foreign interests that have capitalized on patience, competitiveness—and a ‘perfect storm’ to come out on top.

Imagine, an Asian baseball team—patient, innovative, and with good management taking advantage of an injured A-Rod, poor umpiring, marginal management, and an onerous union contract stating all the bench has to play, to win a world series—would we throw the Yankees to the curb and claim that in love, war, economics, and baseball all is fair? We think not.

We can’t decide as a group—let alone as a class or society whether we should have bailed out GM or not, but each of us has decided as an individual. We have provided you with arguments both for and against the bailout and have provided some context within which to ponder the question. Most of you are Americans by birth or by residence and you are all students of economics, therefore—you decide!

[1] Shortly after the war, in 1953 GM’s CEO, Charles “Engine Charlie” Wilson was nominated as secretary of defense by President Eisenhower.

John R. Vigil, MD
Jeff Lambert
Jeff Collins
Natacha Peter-Stein, MS
Tommy Sanchez
Thomas Montano
Marlena Parker
Eric Boatman

Anderson School of Management,
University of New Mexico
EMBA Class of 2011

Tuesday, November 24, 2009

Bitter pill for taxpayers: Drug ads do nothing but boost drug prices

Melly Alazraki Nov 24th 2009 at 4:40PM

A new study published in the Archives of Internal Medicine found that direct-to-consumer drug advertising may be associated with increased drug prices -- and little else. Specifically, researchers looked at blood-thinner (anti-clotting) drug Plavix, which is commonly prescribed for heart conditions. They found that advertising aimed at consumers did not actually increase the use of the drug. However, because of the increased expenditure for advertising, the price of the drug increased, and so did the reimbursement cost of Plavix for Medicaid patients.

"The cost of drugs to public and private health insurance programs has been a long-standing source of concern among policy markers," wrote the study's authors, Michael Law of the University of British Columbia and his colleagues. Indeed, several members of Congress have asked the GAO recently to examine allegations of price gouging on drugs, especially in light of the ongoing debate over health-care reform legislation.

Prescription drug prices are cited as one of the three top reasons for Medicaid expenditure growth, and prescription drug costs have increased by an average of 15.4% per year between 1994 and 2004. Meanwhile, spending for direct-to-consumer drug advertising has increased more than 330% in the last 10 years, the authors write.

Bristol-Myers Squibb (BMY) and Sanofi-Aventis's (SNY) Plavix has annual sales of $9.5 billion last year. The researchers chose Plavix because there was no consumer advertising for the drug from 1999 to 2000. Then, from 2001 to 2005, U.S. spending on consumer advertising for Plavix exceeded $350 million, an average of $70 million per year.

The researchers examined data from Medicaid programs in 27 states. Despite all of that advertising, the use of Plavix by patients in those states' programs did not change. More precisely, since Plavix sales were growing, the ad campaign did not accelerate that growth. However, the price of a Plavix pill increased by 40 cents, or 12%, after the ad campaign began. "Overall, this change resulted in an additional $207 million in total pharmacy expenditures," the authors wrote. Add in the additional revenues from the rest of the states' Medicaid programs, and the cost to taxpayers would be much higher. (Perhaps sufficient to cover the cost of the ad campaign?) This latest research builds on results of an older study which also showed drug advertising to consumers had only minimal impact on sales.

Those who are in favor of direct-to-consumer advertising of brand-name drugs argue that advertising makes patients more knowledgeable, allowing them to ask for treatments from their doctors. The opponents of this practice claim that more often, such advertising misleads consumers about the benefits and risks of many drugs. Neither side ever questioned whether ads would increase medication use or not.

Most countries in the world do not allow advertising of prescription medications directly to patients. Meanwhile, Americans spend most than other nations on health-care -- 16% of U.S. GDP in 2007. It seems that both sides in the direct-to-consumer advertising debate are wrong in their estimates of the effect of drug advertising on use. But the research does support what both sides agree on -- that consumer advertising costs contribute to that higher American health-care bill, as the Los Angeles Times wrote.

Not everybody fully agrees with the study's methodology and findings; some suggest, as the authors of the study themselves do, that there need to be more studies done on the matter.

Thursday, November 12, 2009

How Small Business Will Suffer With "Obamacare"

SMALL BUSINESS HAS fought the health-care bill as too costly.

That made Saturday's vote bitter to many of the nation's roughly 30 million such entrepreneurs, if welcome to some."With unemployment at a 26-year high, the punitive employer mandates and atrocious new taxes will force small business owners to eliminate jobs and freeze expansion plans at a time when our nation's economy needs small business to thrive," Susan Eckerly, senior vice president of one of the most powerful small-business lobbying groups, the National Federation of Independent Business, said in a statement Saturday.Added Molly Brogan, spokeswoman for the National Small Business Association: "We have serious concerns about the bill's cost-containment and the long-term implications of the employer mandate and the surcharge tax."

Action now shifts to the Senate, and with many specifics still in doubt, small-business groups are planning to lobby heavily there.The House bill mandates that employers with payrolls above $500,000 must contribute -- for each full-time employee -- 72.5% of the premium cost for single coverage and 65% of the premium cost for family coverage. The penalty for failing to do so is a 2%-to-6% tax on employers with payrolls between $500,000 and $750,000 and an 8% tax for employers with payrolls above $750,000.

The Senate, by contrast, has bills that don't have employer mandates but are highly focused on provisions that give tax credits to those that do contribute to premium costs. One bill from the Committee on Health, Education, Labor and Pensions rewards employers for paying more than 60% of their employees' premiums with tax credits of as much as $1,000 for each single-coverage employee and as much as $2,000 for each family-coverage employee.

Outside Washington, meanwhile, small-business owners are weighing their options and responses.Sharon Evans, chief executive of CFJ Manufacturing Inc., a promotional-products company in Fort Worth, Texas, said she pays 65% of health-insurance premiums for her 100 employees. If she were mandated to pick up more of the cost, as the House bill requires, she said she would consider dropping insurance and paying a penalty. And various tax rebates, as envisioned by prominent other versions, don't necessarily pass muster with her."If you're going to make me pay $100,000 to get everybody insured and you give me an $8,000 tax rebate, well, the answer to that is, pardon my French, 'Hell, no,' " she said. "That's not going to help me out."

Carolyn Morse, president of Powerlung Inc., a Houston medical-device manufacturer, said she hopes a tax credit would help alleviate the cost of paying 100% of health-care expenses for her six employees."I would be in a better position to maintain a status quo, rather than go to my employees and say, 'Guys, you're going to have to pay,' " Ms. Morse said.Under all the bills in Congress right now, Ms. Morse's health insurance would be subsidized, but the amount she would receive would vary based on the amount of the premiums.

The House bill provides that employers with fewer than 10 workers who average an annual wage of $20,000 or less get a full credit of 50% of premium costs. That credit amount decreases as employee count and average salary increases, becoming null once the employee count hits 25 or the average salary hits $40,000.Currently, many employers who don't offer health insurance blame the cost-prohibitive premiums. And those who do say expensive insurance is hindering expansion and hiring.

Premiums for single policies rose 74% for small businesses in the past eight years, a 2009 Kaiser Family Foundation survey found. Firms with fewer than 200 workers are expected to pay an average of $12,696 for family-plan premiums and $4,717 for single-person premiums this year.The price of health insurance is a big concern for Mike Draper, president of Smash, a print-screening and design firm in Des Moines, Iowa. Unlike some business owners, Mr. Draper, who pays 100% of the premiums for his 15 workers, supports a mandate requiring employers to provide health insurance -- as long as small companies get to offer better insurance plans at a more attractive price."If the government offers to pay for 50% of my insurance, I'll say 'sure,' " Mr. Draper said. "But from a macro level, I don't see how that will bring cost down -- that's just selling the same crap but subsidizing it."