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Rewarding the Old Economy vs the New Economy

Thomas Friedman is advocating that we use recovery / stimulus funding to encourage promising new startups instead of bailing out failing businesses:

G.M. has become a giant wealth-destruction machine -- possibly the biggest in history -- and it is time that it and Chrysler were put into bankruptcy so they can truly start over under new management with new labor agreements and new visions. When it comes to helping companies, precious public money should focus on start-ups, not bailouts.

You want to spend $20 billion of taxpayer money creating jobs? Fine. Call up the top 20 venture capital firms in America, which are short of cash today because their partners -- university endowments and pension funds -- are tapped out, and make them this offer: The U.S. Treasury will give you each up to $1 billion to fund the best venture capital ideas that have come your way. If they go bust, we all lose. If any of them turns out to be the next Microsoft or Intel, taxpayers will give you 20 percent of the investors’ upside and keep 80 percent for themselves.

If we are going to be spending billions of taxpayer dollars, it can’t only be on office-decorating bankers, over-leveraged home speculators and auto executives who year after year spent more energy resisting changes and lobbying Washington than leading change and beating Toyota.

I understand the desire to save the Big Three auto firms (well, two of the three; it looks as if Ford may make it on its own). I can imagine the powerful depressing effect their failure would have on our economy. But what makes them special?

Banks are special because they provide credit, and without credit, the economy stalls. Investment banks and reinsurers are special because their failure could lead to cascading effects in the financial sector. Hence we give these businesses special treatment in that we take extraordinary steps to ensure they don't fail. Whether we're taking the right extraordinary steps is up for debate, but most experts seem to feel we need to do something.

But auto manufacturers? What makes them special? Is it their size? GM is the largest manufacturing firm in the Fortune 500 (number four overall, after Wal-Mart, Exxon Mobil, and Chevron), but we're also subsidizing Chrysler, and it has about one-fifth the employees of GM. If we save GM and Chrysler, where do we stop? Would we save General Electric? Hewlett-Packard? IBM? Boeing?

The Big Three are in trouble for the fundamental reason that they've been making bad business decisions for decades -- decisions that have now caught up with them as a result of the current economic crisis. They have vigorously and consistently resisted steps to force them to build cars that are safer, more fuel-efficient, and more environmentally friendly. They have bought labor peace in the short term by committing themselves to providing expensive benefits down the road. They have demonstrated an inability or an unwillingness to build cars that are as reliable as their Japanese counterparts. This leads to an obvious question: what rational basis do we have for believing that if we bail them out now, their behavior will change? No one has yet explained this to me.

Is the right move to force GM and Chrysler into bankruptcy? I don't know. What I do know is that if we are going to bail them out, we need to have extremely clear reasons for doing so -- reasons that don't imply we'll start bailing out other manufacturing firms. And we need to have a clear understanding of why we believe they're going to succeed.

Meanwhile, Friedman is right on in suggesting that if we want to stimulate the economy in a productive way, we should look to entrepreneurs. I'd suggest co-investing as a more workable strategy, but that's a detail. Pumping $20 billion into the venture market is an awe-inspiring thought.

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