Weekend Update: GM, Health Care and GDP

After all the chaos of the past few weeks, the ‘green shoots’, bankruptcies, inflation fears, and the onset of the health care reform campaign, this weekend seems rather quiet. That makes it a good time to recap some thoughts relating to the headline events.

GM:

1. GM’s bankruptcy is a watershed event for the US. Think of the size: GM employs about 210,000 people worldwide and 91,000 here in the US. It has a staggering 463 subsidiaries scattered across 34 countries. Its monthly payroll bill is $476 million. It provides pensions and health care benefits to 493,000 retirees. It has 11,500 vendors and spends $50 billion a year here in the US on parts etc. Its collapse will ripple throughout that entire mess.
2. I have doubts about its survival even when it emerges from bankruptcy. This is because GM needs more than a financial re-organization, it needs a brand revitalization which is far more difficult to accomplish. When GM entered bankruptcy it had assets of about $82 billion and debts of about $172 billion. That’s a dead company by any stretch of the imagination. More to the point: even though some of its recent cars have attracted critics adulation – the Chevy Malibu for instance – it suffers from a severely depleted brand reputation. Producing good cars now after decades of undifferentiated duds may not help in the face of the competition now ramping up for the kill.
3. The entire auto industry is a mess. It suffers from chronic over-capacity and needs to reduce itself to a more profitable size quickly. Presumably the emerging markets of China and India will eventually outpace demand from more mature markets and so innovation and scale advantages are likely to shift similarly. GM’s strong presence in China may aid survival if that is the case.
4. Offsetting that is the likely continued collapse of its brand here in the US. Its appeal to younger Americans is virtually non-existent. Honda, Toyota, Nissan and now Volkswagen have emerged as the suppliers of choice to younger Americans. Volkswagen is building a new factory here to produce 250,000 cars a year as it seeks to double it market share at GM’s expense.
5. GM remains a very dull company. The word is that Obama’s auto task force were shocked at the poor quality of GM’s management. It is old fashioned, lacks focus, and too attached to the plethora of brands that sank the ‘old GM’. Heads will have to roll before we can expect a vibrant new GM to succeed.
6. Even with the drastic reduction in costs that bankruptcy will allow – GM expects to shut fourteen factories – it is still not a low cost producer of cars. It is still burdened with huge pension and health care costs that its competitors do not have to carry, the latest estimate is that each car it will make after bankruptcy will still have to earn $300 just to pay for workers who no longer produce anything.

Overall then I see GM as a 60/40 proposition going forward. All that taxpayer money is designed to give the company a window of opportunity. The macro economic conditions it faces remain daunting. I would not be surprised to see GM going through another bankruptcy procedure a few years from now. Let’s hope not.

“The trade-off between wages and health care costs is the key to getting the average voter’s attention: they are already paying a huge price for the system’s failure”

Health Care:

1. The interesting fact here is that we have no choice but to fix health care. It simply costs too much. The latest estimates I have seen put the total cost of health care at around 18% of GDP this year. That’s an astonishing number. Worse: no one expects it to get cheaper without radical surgery [sorry about the pun]. Indeed as the baby boomers all age and if they consume health care services at the rate their parents did, that 18% is set to become around 40% within a couple of decades. That will bankrupt the country. So something has to be done and quickly.
2. A key fact to remember: the impact of health care on wages. It has been catastrophic. Because the US system depends on employers giving health care as a benefit its rising cost has squeezed employer’s ability or willingness to give pay raises. Businesses look at wages and benefits as a sum cost. If the cost of health care goes up that leaves less cash available for raises. Looking at the trend over recent years the aggregate of wages and benefits has risen quite steeply. But practically all that increase has gone to pay for health care costs. None has gone to wages. So incomes have stagnated. Without controlling health care we can expect wages to stagnate, and even have to fall to accommodate the expense. That is not tolerable. The trade-off between wages and health care costs is the key to getting the average voter’s attention: they are already paying a huge price for the system’s failure. They need to stop that getting worse.
3. The fight will come from the insurance companies who do not want a government provided alternative. In order for them to win that argument it looks as if they will have to offer significant compromises. In particular they stand to lose their ability to refuse ‘pre-existing’ conditions. I am deeply skeptical of the insurers: they have no incentive to offer the kind of comprehensive cost cutting the system needs. Nor do doctors. Somehow if we are to avoid a mandated system, incentives have to be introduced to force rationalization, office cost reductions, reduced test frequencies and duplications, and a better focus on prevention rather than cure. How this can be accomplished without government fiat is very unclear.
4. Paying for the changes will be easier than many people think. First: the system already costs a vast amount, we can accomplish a fair bit of reform by re-allocating what we already spend, rather than by spending more. Second: there is a growing consensus that health care benefits should be taxed. One of the reasons the current system is so bad is that consumers do not bear its costs directly. So they have no incentive to push back against doctors who over prescribe, or against the waste of insurers bureaucracies. By taxing benefits not only do we raise money for reform, but we focus consumers on the cost of the services they are using. Hopefully consumer activism will disturb doctors and insurers enough for them to provide cost effective rather than lavish service.

Solving our health care mess is a high priority for a number of reasons. We need a better return on our investment: right now we have the least efficient system in the world. We need to spend less in absolute terms: we are on a path towards bankruptcy currently. We need to determine whether we want to have our entire population covered: if so, how? If not, why? Even with the difficulties and entrenched opposition there seems to be widespread support for change. I doubt that the resolution will be bipartisan, but this seems to be one area where Obama has the nerve to use the Democrat’s majority. Let’s hope he gets this sorted out this year. We don’t have the money to keep up the current pace of things.

GDP:

1. There is far too much focus on short term numbers and not enough on the long term trends. My fear is that all the talk of ‘green shoots’ will distract us from digging into the sources of our problems and therefore stop us from eradicating them.
2. The banking system needs fixing. It is in an awful mess. It is badly managed and runs on business models that are now proven dangerous. One look at the headlines about government ‘interference’ – usually in the Wall Street Journal – and we can see already that the industry has successfully avoided either taking responsibility for the crisis it started or undertaking reform. The breathless criticism of the FDIC’s suggestion that heads should roll at places like Citigroup, as if that wasn’t blindingly obvious, is an example of this. Indeed the banks have so successfully co-opted government that everyone seems scared to suggest doing much by way of fixing them for fear of failure. failure, that is, of one of the banks. From my perspective the collapse of the banks was a failure of their managers, boards and regulators.
3. On the subject of banks: I urge you all to read John Lanchester’s excellent article in the latest issue of The London Review Of Books. Apart from being an outstanding summary of the crisis it offers up an actual bank balance sheet from The Royal Bank of Scotland. This balance sheet was released to shareholders just two weeks before the bank fell into the abyss where it currently wallows. The lesson I want to highlight is that nowhere in this balance sheet is there a single clue of the impending disaster. None. That the bank’s auditors, managers, and regulators are not all in jail for publishing such an obviously misleading document is beyond me. Without accountability we will not fix the banking system. That means we will not fix the economy.
4. Employment. The outburst of optimism that greeted Friday’s employment report is testimony more to our depressed mindset than to any rational thought. It was awful. Just not as awful as the last few. That is no triumph. For anyone to trumpet a turnaround based on one month’s data is just plainly irresponsible. It is silly.
5. All the vexation about rising US bond rates is similarly off center. There are those who are already despondent over inflation: they are arguing that the uptick in US bond rates over that last few weeks is a sure indicator of the bond market’s anxiety over the level of US debt. That anxiety supposedly is so solidly based that we should stop increasing our debt and start reducing it right now. That’s absurd. These are the same folks who sat back and told us that running up debt was not a problem when the cause was tax cutting. Apparently government spending as a cause throws them into a tizzy. Yes: we will need to cut back as soon as the economy is back on track. No: that’s not yet. A steeper yield curve helps the banks. A modest inflation rate helps deal with debt loads. And until we have an economy operating back near capacity all that increase in money supply gets absorbed as demand and not as inflation. Duh.

Nonetheless we can expect the inflation fear mongers to be out in force over the next few weeks. I imagine this is set to become a regular topic for us to talk about.

So the trilogy of issues to watch for in the next phase of the recession: structural reform of the health care and banking systems; the balance between monetary and fiscal policy; and capacity – which includes the employment outlook.

That’ll keep us busy.