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European auto maker bailouts,
Michael Sohn/AP

Will American Bailouts Hurt World Trade?

November 24, 2008 02:30 PM
by Anne Szustek
As the U.S. government weighs a rescue plan for the Big Three automakers, European car manufacturers cry foul.

Would a U.S. Bailout Throw a Wrench Into World Trade?

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As U.S. automakers continue to plead their case for a $25 billion federal bailout to keep themselves afloat, European automakers are watching the negotiations to see how a bailout will affect their home car brands—and whether it will give rise to a trade dispute.

At issue is the possibility that European manufacturers will have to compete in the global marketplace against American companies that are being subsidized. As such, the European Union is considering filing a legal complaint against any such U.S.-backed bailout. But General Motors, Ford and Chrysler have long pointed to European government policies that, the big three American automakers maintain, have unfairly abetted their European competitors, such as state-run health care and pension systems for employees.

Garel Rhys, a professor of automotive economics at Wales’ Cardiff University, told Bloomberg, “Frankly, it’s stones and glass houses. Everybody has been at this game for their own interests; nobody is pure.”

European automakers are asking for a total of $50 billion in low-interest government loans to help them upgrade their factories to churn out cars whose emissions would meet strict EU guidelines to go into effect in 2012.

As in the United States, car sales in Europe have been sluggish of late—down some 15 percent in October, the sixth month in a row of a decline in sales. France’s Peugeot Citroën announced on Nov. 20 that it was cutting 2,700 positions, or about 2 percent of its staff in its home country. And German carmaker Opel—a subsidiary of GM—is asking the German government for what German Chancellor Angela Merkel termed “somewhat more than” €1 billion (about $1.25 billion) in credit guarantees. The government of Opel’s home state of Hesse has already pledged loan guarantees of up to €500 million.

The predicament of Europe’s auto manufacturers is not nearly as dire as that of their American counterparts. But if the opportunity to cash in from a bailout should present itself, there will likely be no shortage of manufacturers waiting with cup in hand. Sergio Marchionne, the head of Italy’s Fiat, was quoted as saying in BusinessWeek, “Either [aid] is for everyone or for no one,” pointing out that he should be on the same footing as his competitors.

Some voices from within Europe are skeptical of an automaker bailout. Some, as is the case in America, gesture toward other struggling sectors that could use the funds. Others, such as EU antitrust chief Neelie Kroes, said Nov. 21 at a summit in Brussels that the EU would be well advised to step away from the “costly trap of a subsidy race,” as well as give undue extra credit to manufacturers that may have been slow to institute green standards in their new cars, as has Fiat, whose small models are energy-efficient by design, as BusinessWeek notes.

Kroes also said, “The temptations may be greater now for member states to give subsidies that can result in their economic problems being exported to their neighbors,” stressing that EU rules on aid are meant to benefit the 27-member bloc as a whole, rather than individual members over others.

Historical Context: Prior governmental automaker bailouts in America and abroad

The U.S. government has stepped in to bolster U.S. firms during financial downturns in prior decades as well. In 1979, as the country was wrangling with stagflation, Congress approved a $1.5 billion loan to U.S. automaker Chrysler. Its 1979 deficit was around $1 billion, making it at the time “the gaudiest splash of red ink in U.S. corporate history,” as Time magazine put it. Taxpayers were at risk of footing the bill if Chrysler, then the country’s third-largest carmaker, defaulted. Sen. Barry Goldwater, R-Ariz., was quoted by Time magazine as saying that the loan was “the biggest mistake Congress has ever made.”

President Jimmy Carter signed the loan bill into law early Jan. 1980. Over the following decade, under the leadership of CEO Lee Iacocca, Chrysler crept out of near bankruptcy and quickly paid off its loans.
The United Kingdom has also had to step in with funding to rescue struggling domestic carmakers.

In 1971, the British government under Conservative Party Prime Minister Edward Heath nationalized Rolls Royce after it filed for bankruptcy. The development of the RB-211 engine was proving too lengthy and costly for the company. Questions remained as to the viability of its longstanding contract with Lockheed. The car production unit would be spun off into its own company in 1973. What was left of the company, namely the aviation divisions, was privatized in 1986 during the tenure of Conservative Prime Minister Margaret Thatcher. Rolls Royce the car production company is currently owned by German automaker Volkswagen, who bought it in 1998; Rolls Royce the aviation parts company is still independent, and is the world’s second-largest producer of aircraft engines after General Electric.

On the flipside, British Leyland, a combined group of British car makers established by the Labour Party in the private sector in 1968 and taken into state control in 1975, was dubbed by the BBC “one of the biggest disasters in the history of nationalization.” Before it was nationalized, it had become evident that the conglomerate was struggling to compete against international car brands. After Britain took British Leyland into control, the company’s share of the market continued to dwindle. Car makes known traditionally to be British, such as Jaguar, MG and Aston Martin, are now all under ownership by foreign parties.

Related Topic: The global bailout blitz

Observers at home and abroad have perceived incongruities between the laissez-faire economic ideals championed in the United States and its lifelines to insurance conglomerate AIG and others. “We have the irony of a free-market administration doing things that the most liberal Democratic administration would never have been doing in its wildest dreams,” American financial historian Ron Chernow told The New York Times.

AIG, despite its name, was founded in China—in Shanghai in 1919, to be exact, by Cornelius VanderStarr—from which C.V. Starr, the company of former AIG CEO Hank Greenberg gets its name. AIG has a large employee base there and owns nearly 20 percent of the stock of state-owned People’s Insurance Company of China. Given that Asian financial holdings have been a fundamental source of foreign investment in the United States, it makes financial and diplomatic sense to shore up a company that plays a key role in Asian confidence in American companies in general.

“When the dust settles, I think Asia will come out ahead of the U.S.,” Henry Lee, the managing director of a Hong Kong investment advisory firm told The New York Times. Financial analysts see Asian markets bouncing back more quickly from the current economic lull than America’s, for one. China’s 2007 economic expansion of 23 percent in dollar terms is testament to this. True, double-digit growth is common among emerging markets.

But tiger economies are not to be overlooked—especially when they start pulling securities out of developed ones, like those of the United States. According to statistics cited by The New York Times, central banks, many of which were Asian, bought up $18.2 billion of U.S. securities in July, compared to a monthly average of $22.3 billion during first-half 2008. China’s central bank controls some $1.8 billion in reserves, “grew $280.6 billion in the first half of this year—a pace of $64 million an hour,” writes the Times.

Conversely, the weak dollar could also entice foreign investment into the United States. German insurers Allianz and Munich Re are looking to make inroads into American markets, and cheaper acquisitions may just be the ticket.

“I don’t think you can reach satisfactory growth numbers if you are not a substantial player in the US,” Michael Diekmann, Allianz’s Board of Management Chair, was quoted as saying by German newsmagazine Der Spiegel. “From what I see of some of our competitors in the US, this is not a bad time to look at the US market.”

Especially when European banks have caught America’s financial flu. On Oct. 1 the European Commission made a proposal to update bank lending regulations in an effort to limit fallout from the spreading U.S. economic crisis.

If adopted, the new guidelines would set a cap on how much EU banks can lend to any one party. In addition, any bank that sells securitized debt—including securities backed with bad mortgage debt—would have to split the risk with buyers, by keeping a stake of at least five percent in the commodity being sold.

“These new rules will fundamentally strengthen the regulatory framework for EU banks and the financial system,” Charlie McCreevy, internal market commissioner for the European Union, said in a statement.

The proposal is only the latest among several moves to bolster banks taken within the past week by authorities in the 27-country bloc. Some individual EU members have taken a more radical approach, with some member states acting to take over or “nationalize” banks that are struggling during the credit crunch.

Several EU countries have come up with major infusions of capital to shore up ailing banks. Six major Irish banks are to receive a total of €400 billion ($582.54 billion) in financial protection from the Irish government over two years.

On the Continent, Brussels-headquartered bank Dexia is slated to get €6.4 billion ($9.32 billion) from three European governments: €3 billion each from Belgium and France, with the remainder from Luxembourg. The capital injection came a day after the bank, the world’s largest lender to local governments, saw its shares drop 30 percent during trading on Sept. 29.

Belgium and Luxembourg, along with the Netherlands, gave €11.2 billion ($16 billion) in capital to Belgian-Dutch bank and insurer Fortis. The three Benelux governments are to become combined shareholders of some 30-40 percent of the bank. Fortis is also to sell its stake in the Dutch bank, resulting in the bank’s becoming partly nationalized.

Germany’s Deutsche Bank was cleared by the EU on Wednesday to take over Fortis’ stake in Dutch lender ABN-Amro, which it bought last year during a break-up bid. Two other major stakeholders in ABN-Amro are Royal Bank of Scotland and Santander.

Non-EU member Iceland nationalized 75 percent of bank Glitnir, one of the country’s three largest banks. The country’s financial sector as a whole is plagued by heavy external leveraging. Credit ratings agencies Fitch and Standard and Poor’s downgraded Iceland’s sovereign credit ratings following Glitnir’s nationalization. Fitch also downgraded Glitnir’s rating, as well as those of two other leading Icelandic banks, Landsbanki and Kaupthing Bank.
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