Twofish's Blog

December 30, 2008

General Motors and Chinese SOE’s

Filed under: china, finance — twofish @ 6:49 am

I’ve mentioned here before that I thought the problems of General Motors were very much like those of Chinese state-owned enterprises in the early 1990’s.  Basically much of the problem is that you have this overhang of health and welfare commitments that prevents the companies from being profitable and also makes it impossible to shut down easily without having lots of political impact.

Three other points:

1) giant corporations don’t behave in the way that free market ideologues think they ought to behave.  The theory was that private corporations ought to be better managed than state owned ones because if they weren’t shareholders would revolt and install new management.  This is often true in smaller corporations, but for large industrial corporations, shareholders are totally powerless because they are not organized enough to actually be able to overthrow management.  There are lots of similarities between shareholders in large corporations and voters in one party states.

Markets are able to provide some discipline in that badly run corporations run out of money.  However again this applies largely only to small and mid-size corporations.  Having a large corporation run out of money and fail is so disruptive that it’s not something you want to have routinely happen.  Also, if you have thirty corporations, and one of them fails, then you still have a market.  If you have three, and one fails, then you don’t.

2) People are greedy and stupid.  CEO’s of American corporations will try to make as much money as they can, just like CEO’s of Chinese corporations.  The thing that you have to be careful about is to set incentives so that in being greedy bastards, the management are actually acting in something resembling the public good.  Much easier said than done, and probably completely impossible if you don’t have any effective oversight.

3) It’s going to be interesting to see what happens with General Motors over the next year and the next decade.  One thing that everyone says is that the changes right now are just temporary and when things get back to normal, we’ll go back to doing what we were doing.  The thing about this is that this reminds me a lot about what people said in China around 1978 when markets were first introduced.  They were originally supposed to be a small corrective to central planning, but history has shown that things often take on a momentum of their own, and it will be interesting to see the surprises that people have in store.

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7 Comments »

  1. 1) Shareholders can always sell. If you can vote, chances are that you could also leave.

    2) Generally, yes. Another similarity worth noting between corporate executives and CCP bureacrats is that as soon as they achieve an adequate level of wealth and power, the focus of their work shifts away from innovation, risk taking and reform in favor of the preservation of the status quo (or avoiding jail).

    3) GM should be carved up by PE vultures into pieces that might be viable in the long-term (i.e subject to market forces), otherwise the US auto industry will continue to function like China’s somehow market like institutions.

    Comment by W — December 30, 2008 @ 9:51 am

  2. 1) Shareholders can sell, but that leaves bad managers in place. If the bad managers are doing something that impacts people that don’t have shares, you still have a problem. The two mechanisms in the US economy to replace managers involve leveraged buyouts and cutting lines of credit. The first gets you into lots of interesting law, but the bottom line is that people have perfected takeover defenses to the point it is impossible to unseat the board of directors of a company if they don’t want to be unseated. The second of letting the company die, works well with small and medium companies. It works very badly with things like Lehman Brothers or General Motors.

    2) The point that I was making is that any system has to deal with the fact that people are lazy, greedy, and stupid. This doesn’t only happen to CEO’s in big companies, private equity managers and venture capitalists have also been known to be lazy, greedy, and stupid.

    Also there is the “cult of the entrepreneur” which also causes problems. There are lots of things that large companies are good at, there are lots of things that large companies stink at. Having a large company try to behave like a small company usually gets you the worst of both worlds.

    3) Private equity might be useful in GM, but it’s not a magic bullet as Cerebus and Chrysler or TPM and Washington Mutual have illustrated. One issue with the auto industry is that it depends on integrated manufacturing and economies of scale, and that doesn’t mix well with the Silicon Valley culture that PE tends to be interested in.

    Also there is no financial reason that GM needs to be carved up for PE. The current market capitalization of GM is about $2 billion, which is easily within the financial resources of a private equity corporation. There are tens of thousands of groups in the United States that could takeover GM if financing were the only problem, but it isn’t.

    The trouble with PE, is that any rational private equity group would demand an amount of control that both GM managers and the UAW would find unacceptable. The other problem with private equity is the ‘who watches the watchmen’ problem. How do you prevent a PE company from coming in, selling assets, pocketing the results, and then leaving the carcass for the government to deal with.

    Also, to put GM under private equity would require government involvement since this would be essentially a hostile takeover of GM, which both the unions and GM managers would be opposed to. The other problem is lack of capitalization. Finally, any company that controls GM is likely going to be subject to a lot of public disclosure and one of the advantages of PE is that they can do things in more or less secret ways.

    However, one good thing about private equity is that PE means that if the problem with a company is incompetent managers, you can neutron bomb the executive suite and put a new team in.

    The connection between General Motors and socialist central planning isn’t coincidental. If you look at what Soviet planners of the 1920’s were looking as their model for, it was American corporations under Alfred Sloan.

    Finally, the reason I think that China has some interesting lessons for the United States, is that China completed a massive and apparently successful corporate restructures of its state owned enterprises, and looking at what China did, should give some ideas on what to do with General Motors. The problem with Chinese SOE’s was that they had legacy pension and healthcare costs, and one essential part of the restructuring was to have the government assume those costs.

    Comment by twofish — December 30, 2008 @ 2:56 pm

  3. The value of PE in this case is that it would better align incentives and the apportionment of risk than would any bailout, that if successful will only get GM back to the status quo ante if those who administer the program succeed. You must be joking about China’s SOEs and reform. Sure they shed some legacy costs, and northeast China has been suffering ever since because promises of assuming social benefits were never fulfilled. Today, SOEs are leaner because they cast off such burdens, which has allowed them to borrow on a massive scale to invest in real estate, the stock market and non-core businesses in which they are failing miserably.

    Comment by w — December 30, 2008 @ 3:27 pm

  4. w: The value of PE in this case is that it would better align incentives and the apportionment of risk than would any bailout, that if successful will only get GM back to the status quo ante if those who administer the program succeed.

    Depends on how the deal is structured. It’s going to be a very messy set of negotiations between GM, the government, the unions, GM creditors and shareholders. If any PE thinks that they can make money off of it, great. Right now, the situation is such that any rational PE company would just run away, and getting things to the point where PE would even consider touching the mess will take some doing.

    w: You must be joking about China’s SOEs and reform. Sure they shed some legacy costs, and northeast China has been suffering ever since because promises of assuming social benefits were never fulfilled.

    All the more reason to keep what factories are open, open.

    w: Today, SOEs are leaner because they cast off such burdens, which has allowed them to borrow on a massive scale to invest in real estate, the stock market and non-core businesses in which they are failing miserably.

    The important thing here is scale. Are the dud loans billions, tens of billions or hundreds of billions or trillions? You can walk along the street and see lots of examples of fraud and corruption. If all of that adds up to say US$50 billion, then it doesn’t matter to me.

    I’m sure that the economic downturn will reveal massive waste, fraud, and incompetence. Economic downturns always do. While everything is growing you can throw good money after bad and cover up problems. When you have a downturn, then this no longer becomes possible and all of the bad gunk starts coming out.

    The question is whether or not the amounts of bad investments are going to overwhelm reserves causing a crisis. We don’t know how large the amount of incompetence is. My guess is that the total bill will come to about $100 billion.

    We do have some idea about the size of the reserves, and my best guess is that the reserves in the holding companies and the banking system are large enough to prevent a crisis once all of the bad stuff starts coming out. If the bill comes out to $100 billion, we don’t have a problem. If it comes out to $750 billion, we do, but I don’t see how the numbers can get that high.

    Comment by twofish — December 30, 2008 @ 9:17 pm

  5. Twofish,

    Excellent blog.

    Regarding your contention that big corporations don’t behave as market ideologues think they should, I don’t think market ideologues have any preconceived notion on how big corporations ought to run. Furthermore, I think the notion that certainly industrial companies are too big to fail is based on the inaccurate premise that there would be no buyer regardless of the price of assets. Removal of non-market mechanisms such as restrictive labor contracts and federal aid would go a long way to establishing the market price for these assets.

    Comment by Observer — December 31, 2008 @ 12:40 am

  6. I always thought GE had the most in common with China:

    http://www.mutantpalm.org/2008/01/01/mao-seemed-to-be-good-model-for-jack.html

    Comment by davesgonechina — January 18, 2009 @ 6:25 pm

  7. There are a lot of similarities between the modern American corporation and the Chinese Communist Party, and those similarities aren’t coincidential. The Communist Party of China is based on the Communist Party of the Soviet Union and the model they had in the 1920’s and 1930’s was heavily based on American corporate and management principles. The basic idea of Soviet central planning is to turn an entire economy into one massive giant corporation. The problem with this is that the defects and flaws of big corporations are barely managable when you have a $500 billion company.

    They become totally broken when you try to extend this to an entire economy. One big problem is that if you have three corporations, then a low level minion has the ability to leave if they don’t like it. If you have one corporation, then they can’t. Also the corporation owns me for twelve hours a day, five days a week, but I have “private space.” If you corporatize an entire society, then they own people for 24 hours a day, seven days a week, and then the supervisor can do all sorts of petty things.

    But there are a lot of similarities between corporate behavior and the behavior of the Chinese Communist Party. The rubber stamp “shareholder’s meeting” in which the Politburo/Board of Directors is elected. The corporate newsletter/People’s Daily. The latest slogan from the leader, which everyone is using to promote their political agena, which no one really believes.

    Comment by twofish — January 18, 2009 @ 8:43 pm


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