As General Motors and Chrysler careen toward insolvency, we the taxpayers are being asked to step in and toss them a lifeline.  The problem is that the American public instincitvely understands that the American auto industry is rife with outdated business practices that need to undergo major structural reform, and the public is right.  I think most of us, however, also think its important to have an American-based auto industry, even if that impulse is purely based on nationalist sentiment.  In the end, the American public would like to see two strong American car companies emerge that can compete with Toyota, Honda, Mercedes and BMW on the global stage.  We should figure out a way for General Motors and Ford to emerge on the other side of this recession, properly structured to compete in the auto industry of the future.

General Motors’ core problem is that it is caught in a web of relationships that were put in place back when it was the dominant producer of cars in the United States.  (Chrysler, on the other hand, is just a plain old weak company.)  GM created several brands to provide customers with diversity of choice (back before there was real diversity from foreign producers), and therefore now is hobbled with too many dealerships, excess production capacity, and an inefficient process for new model development.  It also was caught in the great false assumption of the post WWII period: that production capacity and employment was permanent, so that management and their employees are enemies engaged in a struggle to divide the spoils, rather than a partnership to compete against the likes of Toyota and Honda.

Through that prism, the way these companies have been run starts to make sense.  They can’t cut capacity, because they have a contractural need to maintain their network of dealers, their huge employee bases and their huge number of retirees.  Yes, the management that agreed to those contracts was short-sighted, but they were also dealing with what appeared to be reality at the time.  As fiduciaries, management has run the business to avoid bankrupcty as long as possible.  Either way, bankruptcy was inevitable, and has been since the 1970s.  That time has now come.

Andrew Ross Sorkin of the New York Times lays out how Chapter 11 can work while saving General Motors and "merging in" Chrysler.  GM would be reduced to four brands: Cadillac, Chevy, Buick (big in China) and Jeep.  In my view, Ford should also ditch Mercury and be left with Ford, Lincoln and Volvo.  Production capacity, the dealer networks and the employee base would be sized to make sense for the size of the industry today.  The government would facilitate this process by providing a DIP loan for a pre-packaged Chapter 11 restructuring.  As an American, I would be happy to see two, strong, restructured American car companies emerge on the other side of this crisis, rather than maintaining the three "zombie" companies that exist today.

Arthur Pigou was an economist that pioneered the idea of a "Pigovian Tax" in that the government should tax "externalities", also known as negative side effects.  In economic terms the burning of fossil fuels creates costs beyond just the monetary cost of the fuel, namely the environmental cost of pollution and global warming and the military cost of maintaining the balance of power in the Middle East.  The economically efficient way to discourage the use of carbon fuels relative to "cleaner" fuels (from a carbon dioxide perspective) such as renewables and nuclear.  This is a theme that has been encouraged by Thomas Freidman at the New York Times, where he has been relentlessly promoting a high gas tax to make us live in a more environmentally-responsible manner.

Of course, any national-level politician that proposed just jacking up the gas tax would lose in a landslide.  Such a tax would be regressive and hurt lower income people the most.  The other downside to a high carbon tax is that until fossil fuels were replaced with other forms of energy it would discourage certain forms of business activity in the US, particularly manufacturing and transportation.

So the compromise I propose is simple.  I start with the assumption that we want to wean ourselves off petroleum and coal and move toward alternatives and nuclear.  I also assume that the change would need to be gradual so we don’t jam a stick in the spokes of the economy.  I also must give the caveat that I have done none of the math to know what my proposal means in dollars…I just assume it’s done in a way that’s revenue neutral.

Thus, I propose the following: over 15 years phase in a carbon tax while phasing out the payroll tax (a regressive income tax) and the corporate tax.  In other words, instead of using the tax code in a way that taxes labor and discourages corporate investment, use the tax code to encourage energy efficiency and to encourage companies to locate business activity in the United States.

I really think so.

This is a little bit technical, but a pretty compelling case that the last two decades in Japan is analogue to what is happening in the US today. 

http://www.csis.org/media/csis/events/081029_japan_koo.pdf

Japan’s experience in a post-bubble "balance sheet recession" indicates that monetary policy is nearly worthless, except for liquidity injections, becuase no one wants to borrow in a deflationary environment.  Monetary policy will remain ineffective until house prices return to a level that is less than or equal to fair value on a DCF basis.  (Which will likely overshoot on the downside, sadly.)

Fiscal policy becomes more effective, particularly goverment spending and bank capital injections.  We have been getting capital injections, and the country just voted for more spending, so perhaps we’ll fare better than our friends across the Pacific.

BTW, with Japanese stocks at levels last seen in the early 1980s, Japan probably offers the best long-term equity investment story among developed markets.  Germany, which has been in a similarly long stagnation, is probably also worth considering.

In my October 16th piece, I discussed the idea that 2008 may have been a “realigning” election that ushered in a new wave of Democratic dominance. Here are two more articles that make a compelling case that that is the case:

One from the New Republic

Another from Politico

The centers of the New Economy are all clearly on board the Democratic train, and many of Obama’s policies will be aimed squarely at the economic base of the red states. Oil, gas and coal will decline and wind, solar, ethanol and maybe nuclear will rise. Large scale agriculture will be more regulated, while small scale local farming will be nurtured. Highway spending will be reduced and public transport will rise. Imports of low-cost consumer goods will suffer relative to exports of capital goods. Military spending will likely be restricted. Formerly Republican industries like utilities, pharmaceuticals, health insurance companies, and Wall Street are basically set to become wards of the state, as, potentially, are auto manufacturers and telecommunications companies. The wholesale dismantling of the Republican power structure will make it very hard for them to recover.

In the 1960s, the GOP looked to poach the culturally conservative Jacksonian vote away from the Democrats, and it worked brilliantly under the administrations of Nixon, Reagan and Bush II. But in the process, it slowly drove away its historical base of the northern, Hamiltonian professional class voters over those same cultural issues. Now that we have entered the part of the long cycle that economic conservatism is decidedly on the decline, those voters are likely gone for good. The heavier weighting of economic issues in this election has shifted away the northern Jacksonian voters, too.

There is an interesting precedent for Obama’s coalition: that of William McKinley’s and Teddy Roosevelt’s Republican Party of the early 1900s. It combined Hamiltonians, northern Progressives and northern Jacksonians and was favored by women and minorities. This is basically Obama’s coalition.

For the GOP, the long road out likely looks like the old FDR coalition: socially conservative and economically liberal/populist. It seems weird, but the GOP, if it wants to regain an enduring majority, will need to recognize that its base is in the South, Plains and Rockies and concentrate on crafting an economic program to appeal to the middle class while abandoning its traditional ties to Wall Street and big business. The goal would be to peel the northern working class Jacksonians and minorities away from the Democrats while milking the wealth of the barons of the New Economy.

It is unlikely that such a change will occur anytime soon, however, so I’d expect the Obama coalition to endure, provided he seizes his historic opportunity.