Indiana Economics: The Infrastructure Debate; How Bailouts Destroy American Ingenuity

(By George Edwards, cross posted at Indiana Economics.)

Federal, State, and Local government have been working together, in recent days, to create what they think we cannot create on our own: infrastructure. The American Reinvestment and Recovery Act is an example of this type of thinking at the Federal level. I argue in this case study that not only are these interventions unnecessary, but that they are inefficient. As an alternative to the government monopoly of infrastructure production I conclude that markets will produce better outcomes than governments are capable of. In fact, governments produce stagnation. This is a case study of the efforts of the Tipton County Council, the State of Indiana, and the Federal Government, in the small town of Tipton, Indiana.

There is a widely held misconception that without government there would be no incentive to produce infrastructure and that “free riding” represents such a problem that it is necessary for government to monopolize and produce the necessary infrastructure for industry to thrive in. I propose that our infrastructure would be quite a bit more versatile and much less reliant on being part of a grid in some cases and pervasive production of roads in other cases. The American Reinvestment and Recovery Act is an act that ingrains current inefficient infrastructure which includes centuries old way of schooling, road production, and more. Our government is trying to push us towards green energy and high speed rail. However, much to the chagrin of our current policy makers, our country is ingrained with state produced infrastructure that directly competes with green technologies and mass transit.

The map below shows locations of where either a grant, loan, or line of credit was given to mainly government organizations at the expense of taxpayers. The exception is Abound solar. We will look at the history of Tipton that led to the point of Abound solar wanting to purchase the now abandoned Getrag factory on SR 28 and US 31 in Tipton County.

An aerial view from far away makes it look like the government generously doled out money to what must be a multitude of worthy causes. On closer inspection, each “cause” seems to a political payoff to large voting blocs. ”Reinvestment” is not for normal citizens or small businesses but for very large corporations, unions, and government entities.

A close look at ARRA (Recover Act) spending in Tipton, Indiana illustrates my assertions. Exactly 5 entities became the beneficiaries of ARRA spending and only one is not a government entity.

Tipton Hospital $100,000.00

Indiana Dept. of Transportation $574,885.00

Tipton School Building Corporation $1,248,445.00

Northern School District of IN $764,923.00

Abound Solar Incorporated $5,000,000.00

It seems like the Recovery Act spending is not aimed at anything more than the paying off of certain voter blocs and ingraining infrastructure that competes with free-market forms of infrastructure. Government workers all over the United States are currently being paid to quietly accept the loot the government has worked so hard to confiscate and to reassure their constituencies that this money is necessary to prop up a failing economy. Without this money, they claim, the economy will take a nosedive into a “Paradox of Thrift.” Without government money we will lose our auto industry and all become jobless as the economy collapses like a stack of cards. Of course this is not at all true, but politicians and policy makers want to justify their livelihoods. Their public proclamations of their own usefulness tend to be one sided looks at the directly observable affects of spending while ignoring the less observable affects of taxing.

Abound Solar Incorporated is not a government entity but it received a grant that overshadows the grants given to each of the government entities. This 5 million dollar grant has huge opportunity costs for taxpayers that includes but is not limited to the funding and creation of what very well may be an unsustainable business model due to mitigated demand for free market infrastructure, solar panels, caused by government utility competition. The rest of this case study will illustrate the destructive means that the government uses to produce infrastructure for private companies while mitigating the demand for alternative infrastructure production. These practices destroy the market’s efficiency mechanism that ensures global competitiveness of American companies. These policymakers are effectively betting against the ingenuity of the American People in favor of their naive “ingenuity” that second guesses the market.

Chrysler’s Shaky Past

In 2008 I was sitting in a finance class at IU Kokomo debating the merits of the impending government bailout of the “Big Three” auto manufacturers. The initial bill failed because of the major public outcry against passing such a bill. Everyone in that classroom knew that the bill’s failure was just a temporary setback to what would ultimately amount to the confiscation of 13.4 billion dollars from taxpayers to United Auto Workers and very wealthy stockholders. My Finance Professor mentioned a successful bailout of Chrysler in the 80′s and said that bailouts actually DO work. I was not alive at the time of the bailout but I will quote at length the opinion of an expert who was. Barry Ritholtz explains how the bailout, rather than saving a car manufacturer, destroyed the markets mechanism of making Chrysler more efficient.

Had Chrysler been allowed to fall into bankruptcy, it’s not too difficult to imagine a vulture investor obtaining all of the aforementioned assets, and putting them to good use. Just picture a refurbished Chrysler Corporation – newly recapitalized, minus the onerous labor contracts, pension obligations, and healthcare overhead. Its new owner would have been free to pursue new manufacturing methods, new automobile designs, even new markets – with all the advantages Chrysler itself had, but without the defunct company’s baggage.

A post bankruptcy Chrysler would have been as leaner, meaner and more cost-efficient, and maybe even more fuel-efficient machine than the rest of Detroit. Surely, they would have been willing to take chances on some new designs that broke free of the stodgy boring cars put out by Detroit in the 1970s and 1980s.

Not only would Chrysler have been much more competitive in the US and world markets, their mere existence would have forced GM and Ford to streamline their own processes improve their vehicles in terms of attractiveness, mechanical reliability, and fuel efficiency.

In summary, bailouts impede the market from trading bad business models for good ones. A Public Choice economist may conclude that this is due to the political payoffs that elected officials must give to blocs of voters in order to win popular support. In this case this payoff was to United Auto Workers and very wealthy and influential stockholders. The costs were disseminated and unseen while the benefits were concentrated into the hands of some of the wealthiest people in the world (relatively speaking).

On December 20, 1979, Congress “reluctantly” put taxpayers on the line for $1.5 billion in loans. Chrysler increased its role in the military industrial complex and sold pick-up trucks to the military in order to stay in business. This practice had the effect of propping up union wages and benefits that helped create the need for a bailout to begin with. A Japan bashing campaign became part of their new revamped nationalistic business model. A few successful cars later and Chrysler came back to life. By 1983 Chrysler paid back their creditors back all of the money lent to them which somehow put the government up 350 million dollars (somehow.. I don’t know.. if someone wants to find out for me that’d be great… all of the financing was private).

So Chrysler, being part of our military death machine, (being the biggest producer of tanks) kept it’s part public and part private business model, receiving substantial sums of money from taxpayers every year. This is where we bring it back to the small town of Tipton, Indiana.

Getrag in the Crosshairs

The curious thing about war, and apparently even for the number one tank producer, is that they are very bad for business in the auto industry. According to some militant Keynesians, war stimulates the economy through deficit spending. This is the standard explanation for why the Great Depression ended. This explanation is flawed. Frederic Bastiat, mentioned above, wrote a brilliant essay that dispels this notion under the subtitle of “The Broken Window Fallacy.” True enough, the auto industry was not “stimulated” in this unconstitutional war or any other war in recent history.

In June of 2007 Getrag made a deal with the devil. They agreed to a manufacture transmissions in a factory that would cost $530 million dollars. They would build the factory from scratch and locate it in Tipton County at the crossroads of US 31 and SR 28. Mitch Daniels was right there to take credit for the reported 1,400 jobs that the factory would create.

Indiana’s comeback rolls on. Today is a tribute to the skill of Hoosier workers and the pro-growth climate we are building in our state –Mitch Daniels

The day Mitch Daniels claimed Indiana’s “comeback” was rolling on, unemployment was at 4.5 percent. After 2.5 years of being on a “comeback” our unemployment rate is now 9.9 percent. Yes, this Indiana Princeton educated Governor is as clueless about business cycles as anyone else and is willing to take credit for job creation that, in this case, will never come to fruition.

The consequence of acting in good faith with a war profiteer came back to bite Getrag. Instead of receiving the necessary guarantees from Chrysler that would make it possible for Getrag to secure financing, Chrysler rejected the financing it had worked closely with Getrag to obtain, according one Getrag official. Work on the $530 million dollar factory halted in October of 2008, 80 percent complete. The resurrection and propping up of Chrysler in the 80′s directly led to the bankruptcy of Getrag’s subsidiary here in Tipton, Indiana in the present. Chrysler’s fabricated excuse for rejecting financing were brought to light a couple of days later when they idled workers at their Kokomo transmission plants. Obviously Chrysler was having problems of its own and wanted to use any excuse necessary to recant on their contractual obligations.

Governor Mitch Daniels didn’t hold a press conference to take credit for the 1,400 jobs lost rather than gained due to his “pro-growth” environment he worked so hard to create.

Incremental Tax Financing and why the Market Could do it Better

Is this a failure of the free market that could have been prevented if only the local governments had created better infrastructure? Absolutely not. In fact, quite the opposite. This event is proof that individual companies can foot the bill of their own infrastructure if they deem an endeavor profitable.

The town of Tipton sold 14.1 million in bonds to finance the improved infrastructure around where the Getrag factory was being built. In order to cover themselves they sold a majority of them, 11 million of them, to Getrag and Chrysler and 3.1 million to Harris Bank. This strategy was somewhat ingenious because they planned to pay Getrag and Chrysler back out of the incremental tax revenue that came with the plant being fully operational (Harris Bank as well). If the plan didn’t go through they would only have to pay Harris Bank and not the Chrysler and Getrag bonds.

These companies paid for, in advance, almost the entirety of the infrastructure needed to run their own factories. The improvement of State Road 28 was paid for by Mitch Daniel’s “Major Moves” lease of toll roads to private interests.

Getrag had all the incentives in the world to come to Tipton, Indiana because of the ten year tax abatement schedule, free improvement of the road near their factory, the promise to be paid back for purchasing infrastructure bonds, and the 3.1 million dollars in infrastructure paid for by Harris Bank. However, they would have much more incentive to locate in Tipton County if they were not being taxed at all.

Think about it this way: Getrag is looking for a place to locate that has access to all the necessary infrastructure to run a factory. They could locate in a town that monopolizes infrastructure creation, these towns having little incentives to do this efficiently, or they could locate in a town that has no monopolized infrastructure. Then suppose the town with no monopoly of infrastructure has not taxation. Currently companies seek out good infrastructure because there is no option to not be taxed. If this option did exist, however, we would likely see a massive shift in the way successful companies make their decisions regarding location. Monopoly pricing and government production of goods never leads to better outcomes than free markets.

Furthermore, in the absence of government infrastructure monopolies, homes and companies would be a lot more self-sustaining (without forced integration into a grid). A premium would be placed on Green technology that currently has yet to attain the economies of scale needed to mitigate the fixed costs of developing and producing items such as solar panels. Instead of realizing that the problem of progressive energy consumption and transportation is government involvement in those two areas, we have central planners attempting to force us in a direction that markets would have led us to long ago.

One economist thinks that Indiana needs “higher aspirations” and that we should encourage high speed rail. This kind of thinking is an abomination to the profession of Economics and is an example of a failure to imagine the incredible way that spontaneous order and freedom of choice makes people better off in absence of the use of governmental force.

Enters Abound Solar Incorporated

If my arguments above are correct, Abound Solar Incorporated would never have needed the help and encouragement of government in order for its products to be widely accepted in a free market society. Their products would most likely much more advanced than they are now. It is also the case that we would likely already have high speed rail if not for the overproduction of roads and interstates that compete directly with rail. Instead of markets providing the preferred outcomes of market participants, government officials intercede in, compete with, claim the benefits of, and magnanimously tweak market outcomes.

Abound Solar Incorporated produces commercial and utility scale solar panels with a lot of help from government organisations such as the National Renewable Energy Laboratory and the National Science Foundation (organizations that bid up and price out free market industries from obtaining scientists who work there). President Barack Obama announced in a weekly address that the government would be guaranteeing 1.85 billion in loans to green companies, $400 million to Abound Solar Inc. alone. Apparently the free market shouldn’t be left to decide the credit worthiness of Abound Solar Incorporated and our government is. The cost of this guarantee is unseen. A government guarantee effectively pushes away 400 million dollars of investment that would otherwise have occurred by the free choice of market participants. Abound may have gotten 400 million dollars on their own but now the government guarantees it, costing others dearly.

So Abound Solar Incorporated is coming to Tipton, Indiana and getting an expensive factory on the cheap. The factory is selling for $25 million dollars from a group that was owed $45 million by Getrag at the time of the constructions was halted. The 500 million dollar factory, however, will not have the 500 million dollars worth of productive capabilities it would of had if it were producing dual clutch transmissions, it’s originally intended purpose. Instead, Abound Solar will have to renovate the factory using $500 million more dollars and going into debt to do so. This debt decreases the likelihood of the survival of Abound and being bailed out by the Federal Government will no longer be an option due to the impending debt and currency crisis the United States will likely face. Getrag’s factory provides us with a great example of what Austrian Economists call “malinvestment” and the heavy cost of liquidation and rebuilding after such malinvestment.

This does not deter Tipton County Council from trying again. They are still on the line for 3.1 million in bonds issued to Harris Bank for the infrastructure they built near the factory but are issuing 13 million dollars in bonds in order to lower the cost of the factory for Abound to purchase it. These bonds are being issued to Franklin Trust. In total, Tipton is risking 16.1 million dollars, a decision likely due to the initial 3.1 million being owed to Harris Bank probably due to Tipton County’s inability to tax their taxpayers enough to cover it.

The latest news on Abound is that they must prove that they can produce panels at a low cost before expanding to Indiana. As of right now the sale of the factory has been delayed due to their inability to do this in a timely manner. The cost of energy that Abound is producing is well above 80 cents per watt due to it’s high production costs. A competitor, First Solar, is producing panels that produce watts of energy at 80 cents and will likely improve efficiency to 70 cents per watt. Abound likely needs some economies of scale to compete.

What now?

As we move into 2011 where will Tipton go from here? The first order of business for county employees is to give themselves a pay raise. There is also talk of a local option income tax being implemented in order to tax the overtaxed populace of Tipton County to pay for the follies that the County Council Members entered them into. The County Council has enough faith in itself to put taxpayers on the line for millions upon millions more in a likely unnecessary gamble over the success of Abound Solar (these bonds apparently won’t be issued until the sale of the factory and will be paid back by the factory as the factory is in the Incremental Tax Financing zone).

The Recovery Act has delegated 5 million dollars of stimulus spending to Abound Incorporated for the factory. Tipton County will be issuing 13 million more in bonds. The unseen costs of all of this will be devastating to the economy but more devastated would be Tipton County if this firm fails. Like I said above, the ironic part of this is that a company like Abound Incorporated would likely thrive in the absence of a government monopoly on utility production that it deems necessary for people to have.

In the face of this unknown irony, President Obama paid a visit to Kokomo, IN to tout what he considers “stimulus success.” He bailed out the failed business model of Chrysler and transferred a large part of this countries wealth to the United Auto Workers. No analysis of opportunity cost was given. No acknowledgement of past bailouts was given. Obama conflated “America” with “American Government” and warned people not to bet against it. There is a lot of gambling going on in this country but never with pleasure and ease as the gambling of taxpayers money by government officials. By proliferating these bailouts it is Barack Obama who is betting against the ingenuity of the American people in favor of his own preferences.

Chrysler is back in business. Unions are again well funded. The two idled transmission plants in Kokomo are up and running again with the promise of $800 million in more investments to come. No new business model has been applied to the current costly model of Chrysler. The market has been denied it’s ability to make efficient the currently inefficient Union based workforce in Kokomo. The Unseen costs remain lost to even the most astute observer.

Is there any hope? Yes! Encourage local governments to abandon taxation in favor of allowing people to associate with each other without the inefficient government monopolizing utility and transportation production. The free market will provide a better alternative to infrastructure production, one that doesn’t doom towns to infrastructure stagnation based on old ways of thinking. Allow the market to push and pull at the way people live, move, and consume energy. Tell your local leaders that they are unnecessary and more often than not CAUSE the very problems they are trying to fix.

Much bigger and better factories can be built in the absence of government infrastructure that comes at the expense of heavy taxation. If government officials think we cannot afford to purchase our own infrastructure, what makes them think we can afford to purchase it in combination of a costly Government bureaucracy?

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