How Capitalism Will Save Us

by Steve Forbes

  There’s no question that Detroit is responsible for numerous mistakes. Many American auto offerings in recent decades have failed to excite consumers. Auto companies also acceded to crushingly expensive labor agreements that dampened productivity. But that is not the only reason these companies are in the trouble they are today. A relatively little-known irony is that GM and Ford do well selling small, fuel-efficient cars in foreign markets. They are unable to include those cheaper, foreign-made cars in their fuel-efficiency averages because the U.S. government, responding to pressure from politically powerful labor unions, requires that 75 percent of their models be made with at least 75 percent domestic parts to count in their Government Corporate Average Fuel Economy, or CAFE, averages. Thus, to meet government standards, automakers are forced to manufacture more vehicles here, forgoing needed profits.16

  CAFE standards currently require fleet fuel efficiencies averaging twenty-seven miles per gallon for cars and twenty-two miles per gallon for light trucks. Originally enacted in 1978 in response to the Arab oil embargo of the 1970s, CAFE standards are set to increase to thirtyfive miles per gallon as a result of the Energy Independence and Security Act signed into law by George W. Bush in 2007. President Obama proposes to increase the cost burden of these regulations still further by raising CAFE standards to thirty-nine miles per gallon by 2016.

  Of course, European governments get people to buy small, energy-efficient vehicles in a more direct way—they tax the heck out of gasoline. But American politicians know they can’t do that. So they try to achieve the same result via fuel-efficiency regulations.

  The other problem, of course, has been excessive labor costs. Detroit exemplifies what happens when companies are kept from responding to Real World market pressures, when they’re forced by unions to pay for labor they don’t need and “legacy” –i.e., healthcare and pension—costs they can’t afford. Forbes automotive editor Jerry Flint writes that while billions of taxpayer dollars have been poured into unionized Detroit manufacturers, nonunion automakers in other parts of the country—subsidiaries of overseas automakers like Toyota and others—are doing fine without bailouts. It took a while, Flint writes, for American “transplants” to learn how to manufacture here. But eventually they did.

  Toyota solved its problems, while the Detroit automakers collapsed. One reason: the unions.

  The Detroit auto plants are all unionized (United Auto Workers), and union stewards are on the company payroll at every car plant, at a cost of millions of dollars. The UAW works to keep the production pace down. One transplant plant manager who used to work for Detroit figures his people were working 10% faster than at a Detroit plant. If Detroit workers did 50 jobs an hour, his people did 55.

  Detroit pay and benefits ran about $55 an hour, vs. an average of $45 for the transplants, with Korean automakers paying less. Those “legacy” costs—health care and pension payments to retirees—add another $16 an hour to the domestics’ costs. So Detroit’s total labor runs about $70 to $75 an hour, vs. $49 for Japanese transplants.17

  Flint says it’s not only about money. Japanese and German companies that manufacture here also “put particular emphasis on teamwork and quality.”18 And the products show it.

  Because government helped create the mess, a limited bailout to keep Chrysler and GM from collapsing could be justified. But that’s a long way from where we are today. GM and Chrysler have been forced into a government-managed restructuring, while Chrysler is being forced into a government-designed solution that entails giving itself to Fiat. Government and unions ended up owning substantial shares of both companies.

  Instead of having companies reorganized in Chapter 11 bankruptcy, we have a third-world, Venezuela-like solution. The companies are being turned over to United Auto Workers. Senior creditors are having to give up far more than they would in Chapter 11. This trampling of contracts not only is a gross violation of the spirit of the rule of law but also sets an awful precedent for the future. Investors are going to demand far higher prices for capital, knowing that they now bear not only normal market risk but also a very real political risk. Or worse, they may make fewer investments than they would have otherwise. Long-term, the economy will suffer.

  Putting aside the political reorganizations of GM and Chrysler, there’s the very real question whether those two companies will be viable with government and unions dictating how the companies will be run. Politicians love green cars. But consumers may not. Thus GM may turn out green cars that need subsidies of five thousand to seven thousand dollars per vehicle.19

  And then there’s the Real World question: what do politicians, many of whom have not even worked in the private sector, know about successfully selling cars? In the spring of 2009, administration officials temporarily barred Chrysler from spending money on marketing. How does anyone sell anything successfully if they can’t market it?

  The debacle of Detroit offers a painful Real World lesson about what happens when politicians and others attempt to micromanage a market and reduce the “brutality” of capitalism. They inevitably fail—and produce even more brutal consequences. In the case of the automakers, the effort to save Detroit from itself resulted in the needless spending of billions of the hard-earned dollars of countless taxpayers, and it wiped out holdings of creditors and shareholders—not just equity funds but individuals who had invested in GM stock. It forced dealers to close and lay off employees. And it will still result in the loss of worker jobs. The new GM will be smaller, with at least 20,000 fewer workers. In 1970, at the peak of its power, GM employed 395,000 blue-collar workers. That number is slated to go to 38,000 after the reorganization.

  Not only will Detroit jobs be lost. Many more jobs in the larger economy will never come into being, because of the higher taxes that will be needed to pay for this “rescue.”

  REAL WORLD LESSON

  Detroit’s collapse under the burden of government regulations and excessive labor costs illustrates how efforts to soften the “brutality” of markets can end up producing far more destructive consequences, destroying companies and jobs.

  Q WHY SHOULDN’T THE GOVERNMENT STEP IN AND CREATE JOBS DURING AN ECONOMIC CRISIS?

  A BECAUSE GOVERNMENT-CREATED JOBS DIVERT RESOURCES AWAY FROM ENTREPRENEURS AND BUSINESSPEOPLE WHO CREATE REALJOBS PRODUCING GOODS AND SERVICES THAT CUSTOMERS ACTUALLY WANT.

  Barack Obama promised during his presidential campaign to create “five million new jobs that pay well and can’t ever be outsourced.”20 Shortly before taking office, he announced his solution to the mounting unemployment resulting from the economic crisis. His administration would generate or preserve 2.5 million jobs over two years by spending billions of dollars to rebuild roads and bridges, modernize public schools, and construct wind farms and other alternative sources of energy.

  It’s easy to see why so many people believe that government-created jobs are a solution to a down economy. Job programs sound like a swift and decisive response to high unemployment. Why not put people to work expanding and repairing the nation’s infrastructure or working on “green” projects? Aren’t these worthy undertakings that would have to be done at some point anyway?

  The only problem is that in the Real World, public-works programs—contrary to what many believe—have rarely, if ever, been shown to be an effective solution to economic recession or even depression.

  French economist Frédéric Bastiat explained why back in 1850. He wrote about what he called the “broken window fallacy.” This story is famously retold by economist Henry Hazlitt in Economics in One Lesson.21 A boy throws a brick through the window of a local bakery, shattering the window and raining glass over cakes and pies. The bakery owner is enraged by this vandalism. Bystanders tell him to look on the bright side. What looks like an act of destruction will end up creating work for people.

  It will make business for some glazier. As they begin to think of this they elaborate upon it. How much does a new plate glass window cost? Two hundred and fifty dol
lars? That will be quite a sum. After all, if windows were never broken, what would happen to the glass business? Then, of course, the thing is endless. The glazier will have $250 more to spend with other merchants, and these in turn will have $250 more to spend with still other merchants, and so on ad infinitum. The smashed window will go on providing money and employment in ever-widening circles. The logical conclusion from all this would be, if the crowd drew it, that the little hoodlum who threw the brick, far from being a public menace, was a public benefactor. 22

  Wait a minute. It may look like work and wealth are being created by the broken window. In fact they’re not. As Hazlitt retells Bastiat’s tale:

  The shopkeeper will be out $250 that he was planning to spend for a new suit. Because he has had to replace the window, he will have to go without the suit (or some equivalent need or luxury). Instead of having a window and $250 he now has merely a window [our italics]. Or, as he was planning to buy the suit that very afternoon, instead of having both a window and a suit he must be content with the window and no suit. If we think of him as part of the community, the community has lost a new suit that might otherwise have come into being, and is just that much poorer. The glazier’s gain of business, in short, is merely the tailor’s loss of business. No new “employment” has been added.23

  The broken-window fallacy is the idea that destroying wealth—the baker’s window—can produce new wealth for those who rally to replace it. What really happens is that wealth is transferred from one group of individuals (the baker and the tailor) to another (the glass maker and his suppliers). And the baker ends up with a loss—the $250 he would have spent on a new suit.

  The same can be said of government job programs: People see the work and jobs that are being created. What they don’t see is the wealth that is destroyed so that this activity can take place.

  Government finances its job programs through heavier taxation of people and businesses. Or, as Obama initially plans to do, through borrowing. Either way, the government takes funds that otherwise would have been used for new business investment and consumer spending. People being recruited to work in government-sector jobs would otherwise have been available to work in growth-producing private-sector businesses. In other words, money and jobs are simply transferred from one sector to another to fix the “broken window” of the economy.

  ABC broadcast journalist and commentator John Stossel has a good explanation of why government job programs are ultimately useless.

  Creating jobs is not difficult for government. What is difficult for government is creating jobs that produce wealth. Pyramids, holes in the ground, and war do not produce wealth. They destroy wealth. They take valuable resources and convert them into something less valuable.24

  Stossel points out that President Obama’s plan to put people to work in so-called green jobs, weatherizing buildings, and other public-works projects, doesn’t create growth or produce innovations that raise living standards and help society advance.

  Instead of iPods, great art, cures for diseases, and machines that replace backbreaking work, we get the equivalent of digging holes and filling them up.25

  Economist Thomas Woods Jr. compares the process to using a bucket to move water in a pool from the deep end to the shallow end. Government is generally not in the business of creating innovative goods and new technologies that make the economy expand.

  In those rare instances when it does, usually in the military, the application remains narrow. Job and wealth creation are limited or virtually nonexistent.

  Case in point: the Defense Advanced Research Projects Agency (DARPA) invented the Internet in the late 1960s to facilitate communication among universities doing defense-related research. But the network encompassed only a handful of academic computers until the late 1980s, when it was opened to commercial Internet service providers like CompuServe and others. Only when the private sector gained access did the Web truly take off and become the revolutionary force and job creator that we know today.

  Government originated the computer during World War II to help calculate the trajectory of artillery shells. Obviously, computers have wider applications than aiding artillery officers. It was the private sector that ultimately made computers into necessities we cannot live without.

  In contrast, it did not take twenty years for Apple to create thousands of jobs after inventing the iPod. Researchers at UC Irvine estimate that the revolutionary device has created more than 41,000 jobs—from engineers to retailers. That’s probably a conservative estimate, as their study leaves out thousands of people who make and sell iPod accessories, as well as those who are in the business of creating and marketing podcasts and other content.

  Proponents of government job creation point to FDR’s famed public-works programs of the New Deal, which, they say, helped pull America out of the Great Depression. This is a myth. Economist Amity Shlaes is one of an increasing number of historians who make a powerful argument that the public-works programs of that era actually kept the economy from recovering.

  Shlaes acknowledges that those projects “created enduring edifices,” such as New York’s Triborough Bridge, the Mountain Theater of Mount Tamalpais State Park near San Francisco, and the Texas post office murals. But they ultimately failed to fix the economy. The reason: “Public jobs did their work inefficiently. That was because the jobs were scripted to serve political ends, not economic ones.”26

  In the Real World, the economy grows and creates wealth by innovating and improving efficiency. Increased efficiency results in profits that can then be invested in growth and expansion, replacing capital destroyed elsewhere. But the government during the Depression was doing exactly the opposite: creating wasteful, make-work jobs that produced little economic benefit for anyone other than the people being paid to create them.

  While researching her widely read book The Forgotten Man: A New History of the Great Depression, Shlaes came across the example of a government farm in Casa Grande, Arizona, that employed workers who were “poor—close to ‘Grapes of Wrath’ poor—but sophisticated.” She recounts,

  They knew that the government wanted them to share jobs. But they saw that the only way for the farm to get profits was to increase output and to stop milking by hand. Five dairy crewmen approached the manager to propose purchasing milking machines to increase output. They even documented their plea with a shorthand memo: “Milking machine would save two men’s labor at five dollars per day. … Beginning in September would save three men’s wages or $7.50 on account of new heifers coming in.”27

  What was their manager’s response to their efforts to save labor and boost the farm’s profit? He fired them. “The government man was horrified at the idea of killing the jobs he was supposed to create.”

  Making matters worse, these public-works jobs were being created with capital that could have generated real jobs. Government taxation and the sale of bonds, Shlaes says, effectively sucked all the air out of the economy, appropriating capital that would have been available for growth-producing private-sector investment:

  Utilities are a prime example. In the 1920s electricity was a miracle industry. There was every expectation that growth in utilities might pull the country through hard times in the future.

  And the industry might have indeed done that, if the government had not supplanted it. Roosevelt believed in public utilities, not private companies. He created his own highly ambitious infrastructure project—the Tennessee Valley Authority (TVA). The TVA commandeered the utility business in the South, notwithstanding the vehement protests of the private utilities that served that area. 28

  Ultimately, Shlaes writes, public jobs were a Band-Aid solution: “The New Deal’s emergency jobs were short term, lasting months, not years, so people could not settle into them. This led to further disruption.” Shlaes notes that in the best years of Roosevelt’s first two terms, unemployment remained at severe recession levels. In fact, unemployment averaged almost 15 percent before the United St
ates entered World War II. Roosevelt’s treasury secretary, Henry Morgenthau, admitted, “[A]fter eight years of this Administration we have just as much unemployment as when we started.”

  Depression-era programs are far from the only examples of government failure to stimulate a flagging economy through by spreading the work around. Over a more than decade-long recession, Japan launched at least ten stimulus programs—including public-works projects. But none delivered any lasting boost.

  And then there is the question: do people really want all those products and services—green or otherwise—being created? John Stossel points out:

  Since government services are paid for through the compulsion of taxes, they have no market price. But without market prices, we have no way of knowing the importance that free people would place on those services versus other things they want. 29

  Government “stimulus” programs are supposed to deliver a quicker, more immediate boost to the economy than simply allowing the economy’s “invisible hand” to create jobs spontaneously. In fact, it can take years for government programs to work. Many policy makers in 2009 were stunned when a report from the nonpartisan Congressional Budget Office predicted that the $358 billion in proposed infrastructure projects could take as long as ten years to work its way into the economy.30 The report predicted that only about a third of the infrastructure money would be spent by the end of 2010. Most of the government’s rescue package, and jobs, would most likely be delivered after the economy recovered.

  REAL WORLD LESSON

  Government job programs don’t create sustainable economic growth.

  Q DOESN’T WALMART’S IMPACT ON MOM-AND-POP BUSINESSES SHOW THAT SOMETIMES THE “DESTRUCTION” OF CAPITALISM EXCEEDS CREATION?

  A NO. WALMART MAY HAVE HURT SOME BUSINESSES, BUT IT HAS CREATED OPPORTUNITIES FOR OTHER ENTREPRENEURS, IN ADDITION TO LOWERING COSTS FOR CONSUMERS.

  To many, WalMart is not only America’s leading discount chain. It’s a retailing juggernaut that crushes competitors and symbolizes the brutality of the free market. In a New York Times op-ed piece, former Clinton labor secretary Robert Reich, expressing this view, complained that the retailing giant has turned “main streets into ghost towns by sucking business away from small retailers.”31