Young Economics.

Too big to fail

with 3 comments

We’ve heard a lot about ‘too big to fail’ lately. When a major bank teeters towards bankruptcy, policymakers rush in. They say too many people have too many assets connected to the company. One man down means a million will suffer. It’s a very compelling idea, and makes a lot of sense applied inside the financial community. The Lehman disaster in September of last year is the perfect example. But can this ‘too big to fail’ classification apply to companies outside of finance? Or more generally, can ‘too big to fail’ apply to a specific industry inside a country?

Two articles caught my eye earlier this week. Both were connected to the struggling auto sector in Ontario and the inadequacies of the provincial support system to cushion the blow from potential bankruptcy.

1. Ontario pension safety net can’t catch pensioners: McGuinty

2. CAW president slams pension claims

The message they send is clear from the following two excerpts:

1. “The province’s safety net has been in place since 1980, and provides retirees with up to $1,000 a month if a pension plan cannot pay full benefits. Premier Dalton McGuinty yesterday described the money available as “very, very modest… That comes nowhere near meeting any liabilities – for example, for the auto sector alone, to say nothing of all the other sectors,” Mr. McGuinty said… “We would never have all the money that would be needed to top it up to meet all the demands for all Ontarians who are experiencing troubles with their pension plans,”

2. “The president of the Canadian Auto Workers union says governments have stepped away from their responsibilities to protect pensioners. Ken Lewenza was responding to comments by Ontario Premier Dalton McGuinty that Ontario’s pension-plan safety net isn’t large enough to cover auto worker pensions if General Motors goes bankrupt. Mr. Lewenza says governments not backing pensioners is morally, ethically and possibly “illegally” wrong. He says the best way to protect workers’ pensions is to keep the auto companies in business.

The province cannot afford to support the hundreds of thousands of people whose jobs rely on the auto sector. But how can they agree to support an industry with failing prospects? A smart economic planner looks to put their money towards growth and job creation. Unfortunately, the forces seem to be pushing Ontario towards policies aimed at preventing job extinction.

Could it be that the auto industry is ‘too big to fail’ in Ontario? Bankruptcy would mean too many layoffs, too many lost salaries and too much suffering? It seems like Chrysler thinks so, as they bluntly threatened to walk away unless the province pays up (link).

My question is whether this issue has its roots in the very nature of the global economy. Economics tells countries that to win at trade they need to focus on comparative advantage; to make what they’re good at. So if a national industry excels, workers pile in to pump out extra exports, all the while letting other sectors slip soundlessly away. But what happens when the world doesn’t want what your good at anymore? Can a country embrace the winds of creative destruction, or are they systematically anchored to a dying business? It seems like the general recipe we give for economic development pushes this ‘too big’ risk onto countries.

On a somewhat related note, read this great article in the Atlantic by Simon Johnson (link).  My post here has looks at ‘too big to fail’ in terms of the amount of jobs and salaries an industry provides. However, there are political connotations from success as well. As an industry grows, a larger proportion of the voting population are tied to it. Thus industry domination brings with it politicians who support its incentives. In this setting, how can you expect sound policy-making to prevail? Johnson argues this is why the US is unwilling to give up on their banks.

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Written by jk

April 10, 2009 at 8:50 pm

3 Responses

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  1. Are you familiar with BloggingHeads.tv? It is awesome. Here is an interview with Simon Johnson regarding his article in The Atlantic:

    http://bloggingheads.tv/diavlogs/18880

    I haven’t watched it, but it’s probably good.

    Also, here is a good one with Mark Thoma and Scott Sumner:

    http://bloggingheads.tv/diavlogs/18809

    Alex

    April 10, 2009 at 10:21 pm

  2. Nice Alex. I never realized Simon Johnson was a Brit!

    jk

    April 11, 2009 at 2:07 pm

  3. How about relying not only on regulations, but also considering Paul Volcker’s advice from experience: being too big is itself a problem that can and should be remedied? I’ve just posted on it at http://euandus3.wordpress.com/2009/10/25/bigger-banks-too-big-to-fail/

    You might want to read the article I read: http://www.msnbc.msn.com/id/33477077/ns/business-the_new_york_times/

    euandus

    October 26, 2009 at 10:11 am


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