Driven Into the Ground

If you thought that the more than $6 trillion governments around the world have pledged this year to shore up their teetering banks was going to be the end of it, think again. As the financial crisis continues to spill over into the "real" economy and push more and more countries into recession, a growing number of industries are lining up for their share of the aid. Last week it was the car companies' turn, with the U.S. Congress debating (and for now, at least, rejecting) an immediate $25 billion cash infusion for Detroit's Big Three. European automakers called for a $50 billion aid package of their own; Australia passed a $2.3 billion aid package; and even Chinese carmakers, shocked by shrinking exports and domestic sales growth just as massive new capacity comes online, begged Beijing for help. This could come on top of the more than $70 billion governments have either promised or are considering giving to carmakers to help them "retool" for more energy-efficient cars.

But unlike the bank bailouts, which were necessary to avert a global financial-sector meltdown, auto aid is fast turning into an old-fashioned subsidy race. The aid will lessen the pain—a case easily made given the size of the industry, its wide-reaching supply chains and the rapidly worsening state of the economy—but at the expense of cementing many of the industry's problems that long predate the crisis, and have now been magnified and laid bare by the economic turmoil. The triple hit of high fuel costs, the credit crunch and now recession has produced the sharpest demand contraction in decades. In October, auto sales plunged by 32 percent in the United States and 15 percent in Europe compared with the same month in 2007.

As banks cut back on loans to rebuild their balance sheets, companies and their suppliers are struggling to find financing and credit insurance to fund their operations. With all these problems, few lawmakers believed General Motors CEO Rick Wagoner last Tuesday when he told Congress that he needs only a "bridge loan" to tide GM over a temporary dip in demand. J.D. Power predicts an "outright collapse" of global car sales in 2009, with some analysts expecting U.S. sales to drop as much as 30 percent next year—that's on top of this year's decline. Since loose credit to subprime borrowers fueled almost as big a bubble in car loans as in mortgages (and not just in the United States), few analysts expect sales in the United States and Europe to revert to precrisis levels any time soon, even as new car plants still under construction worsen the capacity glut. The result: global surplus capacity is predicted to hit 30 percent, or 29 million vehicles, in 2009.

In that kind of environment, European and Asian manufacturers fear they will have an even tougher time competing with government-favored carmakers. In Germany, GM subsidiary Opel was in negotiations with the German government last week for a $1.3 billion bailout, ostensibly to maintain its cash flow in case its teetering parent falters. In Italy, Fiat chief executive Sergio Marchionne warned that singling out American carmakers and their European affiliates for subsidies would be unfair and distort competition. "That is something Fiat cannot accept," he told a meeting of Italian industrialists in Turin last week. In Brussels, EU Commission president José Barroso has threatened to take the United States to the World Trade Organization if it props up Detroit with aid.

In Europe and Asia, as in Detroit, the question is not just whether to help carmakers, but what strings to attach to any bailout so that it doesn't just prop up zombie companies, their subsidized products depressing market prices—as was the case, for example, with the European coal mines and shipyards that spent decades on life support before dying. In the United States, the consensus seems to be moving toward an aid-financed, bankruptcy-like restructuring of some of the Detroit carmakers, even if they manage to avoid formal bankruptcy proceedings. Conditions might include renegotiating union contracts and shutting down additional capacity. Whether countries like France, where politicians are much more comfortable with state-supported or even nationalized industries, will help solve the industry's capacity problem in return for aid is much less clear. "If everyone just subsidizes, they will conserve dramatic excess capacity," says Clemens Schmitz-Justen, a former BMW executive who now teaches at Clemson University in South Carolina.

But the biggest issue the bailouts fail to address is the future of the industry itself. The automakers, after all, face more than an economic crisis. American manufacturers, especially, also face the death of their traditional business model of releasing ever-bigger models with ever-stronger petroleum-fueled engines. "No one knows whether the future belongs to hybrids, electric cars or ultra-efficient gas-powered models," says August Joas, head of consultancy Oliver Wyman's global automotive practice. It's another reason consumers are holding back, as they wait for new technology to hit the market. They want to get a better sense of what kind of new car will still have resale value once the technology switch proceeds, Joas says, and are uncertain how government plans to steer this process with taxes and incentives will affect the models they might like to buy.

Amid all this uncertainty, it's highly doubtful that politicians have the knowledge to decide which companies to support. Germany's Opel, first in line for a bailout, has long been the country's weakest and worst-managed carmaker. Its share of the German market is down from 20 percent in 1972, when it was the market leader just ahead of Volkswagen, to only 7 percent last month, just as its parent has imploded from 50 percent of U.S. sales in the 1960s to only 21 percent today. "It's not exactly a success story," says Essen University auto expert Ferdinand Dudenhöffer.

Politicians, of course, have a long history of propping up loser companies, dragging down more-competitive companies (not to mention public finances) in the process. That's why Joas says the smarter—and fairer—policy would be to prop up the market by subsidizing car buyers instead, letting them decide which models and companies deserve to survive. That's the direction the EU Commission and several European governments seemed to be moving in last week as they insisted that any aid package be implemented on a Europewide, not national, level. Otherwise, EU Competition Commissioner Neelie Kroes has warned, the explosion of bailouts risks turning into a destructive round of "beggar thy neighbor" policies, akin to the tariff wars in the 1930s that worsened and prolonged the Great Depression.

It's a cliché, but this wouldn't be a crisis if it didn't offer opportunities. In the United States this is a once-in-a-lifetime chance to force real efficiency standards on the industry. Globally, it could force automakers to cut the glut in capacity. American and many European car companies will have to think harder about finding a better business model than building ever-bigger cars at ever-bigger volumes. And it might give a further opening to competitors producing more efficient cars. Such tough love will of course be hard to sustain if and when the recession worsens. But it's something politicians would do well to keep in mind as they jump on the bailout bandwagon.