Industry bailouts in this time of coronavirus

Industry bailouts by governments have been subject to intense debate in this time of coronavirus, including in Australia where the airline Virgin Australia is in voluntary administration and seeking additional financial support from government. Recently, Adept Economics Director Gene Tunny discussed industry bailouts with renowned US economist and commentator Dr Dan Mitchell, Founder of the Center for Freedom and Prosperity and former Senior Fellow at the Cato Institute. Dan regularly appears on Fox News and CNBC and is regularly quoted in the Wall Street Journal and other publications. Gene is grateful that Dan agreed to appear again on his Economics Explained podcast. Please check out the conversation Bailouts in this time of coronavirus. For the transcribed version of the conversation, read on!

Bailouts in this time of coronavirus with Dr Dan Mitchell

Gene Tunny  0:08  

My guest this episode, who is making his second appearance on the program, was described by UK Newspaper the Guardian in 2018 as “a high priest of light tax, small state libertarianism”. In response to this, my guest has written, “I assume they meant it as an insult, but it’s the nicest thing anyone’s ever said about me.” Dan Mitchell, welcome back to the programme.

Dr Dan Mitchell  0:39  

Glad to be with you, Gene.

Gene Tunny  0:40  

Excellent. For people who don’t know, Dr Dan Mitchell is the founder of the Centre for freedom and prosperity and he is a former senior fellow at the Cato Institute. He’s had a long career in economics and public policy so I’m very glad to have you back on to the programme, Dan. Today I’d like to chat about all of the industry bailouts that we are seeing in this time of Coronavirus, and they’re causing a lot of controversy. The other day I saw that there was a billionaire venture capitalist on CNBC, Chamath Palihapitiya, and the host asked him, “Do you think it’s a good idea that the government should be bailing out the airlines and companies such as that”, and to the surprise of the host, Chamath answered, “No”. He didn’t think it was a good idea at all, and there’s actually a process for when businesses get in trouble, “packaged bankruptcy”, is what he was saying. So could we begin by you providing your thoughts on industry and company bailouts and when they could be a good idea, or if they’re not a good idea, when they’re a bad idea, please Dan?

Dr Dan Mitchell  2:10  

The first thing we should probably cover is that there are several types of bankruptcy in the United States. The two most common are reorganisation, where the business keeps going, the workers are still at their jobs but you have a restructuring of things like debt. The idea is that the company is still an ongoing operation, it’s still a potentially successful business. The other type of bankruptcy, the worst, the one that you don’t want to be in presumably, is the total liquidation of the business, shutting the doors, sully I guess a few, you know, materials, whatever you have left, that you basically scrap sale. You totally shut down the company. Now, the challenge we have in the era of Coronavirus is that there are companies that are going bankrupt, not because they did something wrong, they’re going bankrupt because the entire national economies are basically locked down other than a few essential things such as food. And from a, from a sort of hardcore libertarian perspective, we don’t like any kind of bailouts, period. But if we’re going to relax our principles, this would be a time where there’s presumably a legitimate argument that, well, we don’t want to have unnecessary destruction and closure, in many cases, permanent. So let’s just have some sort of universal government programme and what we’ve done in the US, it’s not just one programme, we have one set of guidelines for large companies and another set of guidelines for small companies. But the idea in both cases is it’s not the company’s fault. It’s not the business’s fault. We don’t want the local dry cleaner or the local restaurant shutting down for something that wasn’t their fault. Let’s just sort of spew a lot of money out there, promiscuously spend here and there so that when the Coronavirus fades away, when there’s a vaccine, whatever happens when the economy has a chance to reopen, these businesses are there ready to go again.

Gene Tunny  4:38  

Okay, okay. That’s interesting. So you’re saying because this is something that the government has caused by its policy measures, then there could be a case for some type of intervention. So then we should be good to chat about what that support should look like. And in the US I’ve seen that there’s a mixture of grants and loans to airlines. Is that correct in their support for payroll? Have you been looking into the makeup of that assistance, Dan?

Dr Dan Mitchell  5:13  

Yeah, I won’t pretend to be an expert on the details of the airline bailout. But as I answer this, let me start by giving the ostensible libertarian rationale for bailouts. We have something in the US constitution where the government is not allowed to take private property without compensation. This deals with what’s called eminent domain. And it’s normally applied to things like, you have some land, the government takes some of your land because they want to build the road, they have to give you compensation for that. Some people are saying, well, the national government shutdown order on the economy is equivalent to a regulatory taking, and therefore the government should compensate people. I’m not a legal theorist so I don’t know whether regulatory takings is actually a sound argument from a legal perspective. But it certainly seems to be one that people have latched onto in terms of just what’s right and what’s wrong and what’s acceptable. For my purposes, I may not know what’s right from a legal perspective, but I do know that there is a difference between a bailout like we had in 2008 for select Wall Street firms and what is happening today. I don’t think those bailouts were at all legitimate. You could have had the orderly restructuring type of bankruptcy, where shareholders and bondholders took big haircuts and those financial institutions still would have been there and still operate it. But it would have been an important lesson for the big money people behind those institutions that they shouldn’t have been investing in dodgy government-backed securities like Fannie Mae and Freddie Mac. Nowadays, again, what we’re dealing with with the coronavirus. It’s maybe not from a pure libertarian perspective, something that we like to rationalise as acceptable, but it’s certainly understandable, and it is the result of a government-mandated lockdown. Although I will have to admit, even if the government didn’t mandate a lockdown, people still would have been basically sheltering at home. So I think we probably wouldn’t have the same result. But what really matters, and I’m finally getting around to answer your question here, what really matters is government is doing a bunch of bailouts, they are throwing trillions of dollars around in the United States and I wouldn’t be surprised if we have a couple of trillion dollars more before this is all over and done with. As far as I’m concerned, the number one thing to focus on is to make sure there’s no permanent expansion in the footprint of government in the economy. Okay, fine. We’re gonna bail out big companies, we’re gonna bail out small businesses, but just make it a one-time cash infusion, make sure that once the economy is trending back to normal, that then we have companies allowed to thrive or fail based on whether or not they’re satisfying the needs and interests of consumers. And in terms of the airline industry, that’s a special case, of course, because 95% plus of their revenue has collapsed overnight. Now, in theory, you could say, well, the assets of airlines or their airliners and also their gate assignments and airports. Well, those things don’t disappear if they go into an orderly bankruptcy. So why not just let them go bankrupt, as opposed to giving them a bunch of money? Well, the reason politicians are giving them a bunch of money rather than forcing them into a traditional bankruptcy is because they want to make sure that 10s and 10s of thousands of employees who work at the airlines are kept on the job, or that they’re continuing to get paid. And a lot of what is happening in terms of how official Washington, the national government, is reacting in the US, it is basically designed to make sure that if you had a job, say back on January 15, before this became a big issue, we’re going to make sure that you still have a job today, and if necessary, the government’s gonna subsidise you or subsidise your company in order to keep you on the payroll. A lot of other countries around the world have done something similar, so it does seem to be the standard operating procedure.

Gene Tunny  9:52  

Yes, Dan. That’s a great point about how any type of assistance doesn’t lead to a permanent expansion of government. I agree with that. The challenge is that a lot of the critics of capitalism are saying that this Coronavirus crisis is revealing fundamental problems and that therefore we need to have more of a government role. There are a lot of critics who are arguing that if there is assistance provided to, say, the airlines, governments should take a stake or have the option of taking a stake in those airlines, and it appears that the US government may indeed give itself that option. So, just reading from the Guardian here, “The grants to major airlines including American Delta, Southwest, JetBlue, and United will probably come with strings attached. According to The Wall Street Journal, the airlines had wanted the line to be forgiven but the Treasury Secretary Steve Mnuchin told carriers that 30% of the assistance would need to be repaid and that airlines would have to offer stock warrants giving the government the right to buy shares in the companies on a portion of those funds”. So, it’s probably fair enough that the government gets these warrants, but you wouldn’t want them to exercise them. Is that what you would be saying?

Dr Dan Mitchell  11:28  

I wrote a column specifically on this issue. I do not want any sort of government in the boardroom situation to exist when all this is over and done with. If they’re going to make these grants and the loans or some portion of them into loans, that’s fine. There are all sorts of ways to deal with this. There are no good options, of course, I mean, that’s the sad thing. We’re in this mess. It’s not the fault of any party. It’s not the fault of any ideology. It’s just something that has swept upon the world. I guess you could say it’s partially the fault of China for its lack of transparency and the World Health Organisation for their corruption and helping China hide what was going on but for the most part, I suspect the virus probably would have broken out anyhow, even if China and the WHO were behaving perfectly. So, again, I just come back to, okay, we’re gonna have lots and lots of money being spent by governments all over the world. Let’s make sure that there is not lasting permanent damage in the sense of government trying to control and dictate the economy. As I’ve joked in the United States when talking to reporters on this issue: I don’t want the net result of all this to be Bernie Sanders’ agenda getting adopted in the United States.

Gene Tunny  12:54  

Okay, so what do you see as the long term risks of more government involvement with companies? Could we just cover that for a couple of minutes, please, Dan? What do you see as those long term risks?

Dr Dan Mitchell  13:10  

I guess there are two risks. The short term risk, or maybe short to medium run risk, is the potential of government having stakes and companies and not quickly trying to unwind it. It’s not as if I’m concerned that Mnuchin has some sort of sinister plan to basically be in charge of the airline industry. I think he’s simply saying we’re giving you this money, we want to get some of it back. And to be honest, we did some of that with the TARP (Troubled Asset Relief Program) bailout back in 2008. The government took shares in the banks, but then the banks, of course, had an interest to quickly pay back the government. The government actually made a profit on that part of TARP and even during the Obama administration, there didn’t seem to be any desire on the part of people in the federal government to become permanent shareholders and to have a presence in the boardroom. And I don’t think that’s the case under Trump either. And to be fair, I don’t think the potential Biden administration would want to micromanage the decisions of banks. They might like to regulate them in all sorts of ways that I would find ill-advised, but politicians actually like regulating without direct control. That way, if anything goes wrong, they can always blame the banks or whatever industry they’re regulating, whereas if they actually were a shareholder, and were actually, in effect, visibly forcing banks to make decisions, then all of a sudden the politicians can get blamed if something goes wrong. So, in the short to medium run, I want to make sure that whatever stock holdings or stock warrants, I want all those things to expire, to be liquidated. I want to go back to having, for the most part, a market-driven economy. Now, in the medium to long run, I get probably even more concerned about the potential for government having its thumb on the scale in terms of capital markets. The Federal Reserve has enormous powers, that’s our central bank in the US, under the bailouts but also under existing authority because they’ve always had this, I think it’s section 13(c). They’ve always had this sort of emergency power to inject a lot of money in the economy in any way they see fit, basically. And that means, of course, tremendous ability to start allocating the flow of capital in the economy. And, as you well know, and as most economists know, you want to have private competitive money determining where capital is being allocated. You don’t want politicians doing it because they hate creative destruction. They hate companies going bankrupt. Even though you and I and other economists know, that’s just part of the process that makes us richer over time. As resources flow out of failed ideas into new successful ideas, politicians are always concerned about protecting jobs, even those that maybe perhaps shouldn’t exist anymore. If it was up to politicians, they probably would have tried to preserve typewriter industry jobs by squashing the personal computer. We don’t want politicians with their short election cycle time horizon. We don’t want them deciding how to allocate capital. These bailouts potentially give them that ability, especially through the Federal Reserve. So that’s something I’m concerned about. By the way, you asked a question earlier, and I didn’t answer if this is somehow an indictment of the capitalist system? I wrote a column specifically on that because somebody from the Washington Post, Dana Milbank, wrote a piece saying, “Oh, look at this. We need bigger government. This is evidence that we need big government to do things that are important”. Well, there’s two problems with that argument. First of all, even libertarians, we believe that one of the few legitimate roles for government is protecting life, liberty and property. So I don’t know any libertarians who don’t think there should be a government role in a pandemic. But the thing that really shocked me about Milbank’s column is he cited, as success stories, the East Asian economies like Taiwan, Singapore and Hong Kong. Well, what do we know about countries like that? They have a much smaller government than the United States. In other words, he was trying to make an argument that the pandemic shows we need bigger government, but the only examples he could cite that were being successful in the age of Coronavirus were countries with very small governments. So, this is, as they call in soccer, an own goal. I thought it was an incredibly sloppy argument. And to me, it underscored that, if we want government to be competent, to be able to handle the few legitimate responsibilities that it should have, then we want to keep it very small. We don’t want any talent and ability being spread across all sorts of bureaucracies that shouldn’t exist.

Gene Tunny  18:26  

Oh, absolutely. I agree there, Dan. What it looks like is that some of these East Asian economies with relatively small governments have been pretty successful in containing the spread of Coronavirus. Partly that’s because they learned the lessons of SARS, but it seems that they also have much better administration. Looking at the US from the outside, and it’s always hard commenting on another country because you’re not there, but it looks like it really has spread out of control. Hopefully, it’s getting under control now in the US. But to what extent is that a failure of the federal government? And to what extent is it a failure of the state governments? Do you have a view on that?

Dr Dan Mitchell  19:21  

As a practical and as a philosophical matter, I think state governments are better positioned to deal with this kind of crisis. When you bring in Washington, you’re just adding another layer of bureaucracy, another layer of inefficiency, another layer of politicisation. You see that with Trump’s daily press briefings, I mean, the accusation is that he’s steering resources to governors that are flattering him and holding back resources from ones that are critical of him. Now, that may or may not be true. There’s so much smoke and mirrors in Washington that I reserve judgement on that. But I do know for sure that it would be much more efficient if we simply had states having their own reserves of ventilators, having their own reserves of masks. They know the situation on the ground, they’re much more likely to make capable, intelligent decisions than having a bunch of bureaucrats in Washington because, actually, one of the big lessons we’ve learned from this is that both the centres for disease control and the Food and Drug Administration have, in all likelihood, killed people because of regulatory barriers that prevented the quick production of personal protective equipment, and the quick production and deployment of testing. Hopefully, there’s actually going to be a bipartisan agreement once this is all over and done with that we need to replace the commanding control bureaucracy we have for these things with what’s called permissionless innovation so that the market can very quickly respond, instead of having factories sitting idle, in terms of producing more mass or more ventilators, because they have to wait for some bureaucrat to check a bunch of boxes on a form. It’s basically almost a 1925 regulatory model in a world that is now digital.

Gene Tunny  21:25  

Yes, Dan. One of the points that has been made by critics of “neoliberal policies” is that one of the challenges we’ve had in advanced economies such as the United States and Australia is that a lot of our manufacturing industry has been offshored. That has left us reliant upon products from China, and we lack the self-sufficiency to produce the goods that we need in these times. But from what you’re saying, and correct me if I’m wrong, is your view that there is enough manufacturing capacity in the US to produce the ventilators? And while certainly there would be for the masks, but it’s been a matter of government failure, is that your view?

Dr Dan Mitchell  22:27  

Well, there’s no question that government red tape and bureaucracy has prevented a rapid ramping of production of various tools, equipment, and testing that is needed in this crisis. Now, that being said, it could very well be that it’s more efficient in terms of national and global economies, for some of the low value-added things to be done outside of the United States. You know, we don’t really have much of a textile industry in the United States because it’s a very low value-added industry. A lot of that textile industry is now in places like India, Indonesia, so on and so forth. Well, you know, does it make sense for the United States to mass produce? Maybe it doesn’t. Now, having said that, it could very well be that there’s a legitimate case to be made. I have not studied it, but I think just from a sort of a common-sense look at it, there is a case to be made that perhaps you don’t want to be entirely reliant on a country that might not have your best interests in mind, especially for a critical good. I like to think that over time, China is going to have gradual liberalisation and become more of a normal country. But especially in a crisis, do we want to be totally reliant on China, whether it’s for ventilators or mass or tests or anything like that? Yeah, maybe not. Now, do I have any problem relying on Germany or Ireland or Australia? If that’s where we’re getting a lot of this equipment? No, I would have no problem with that. So I think it’s probably a judgement call. Some countries aren’t necessarily your lifelong buddies and friends, and we probably don’t want to be totally reliant on them for some goods that at some future point in time, I think are really important.

Gene Tunny  24:23  

Right. So, there’s a small exception to free trade where there is something that’s critical for public health and it might be that you want to make sure you’ve got some capacity to manufacture in a time of crisis, or, if not, build up a stockpile beforehand to make sure you’re not going to run out. Just Finally, I’d like to touch on another issue that’s been controversial. It’s this issue of stock buybacks. And this is something I know that you’ve written about and you’ve commented on. What we’ve seen is that a lot of people have criticised big companies for these stock buybacks which are inflating the share prices and enriching their shareholders and also to the management to the extent that they own shares in those in those companies and that they usually have options. What we’ve seen is that politicians have made these requirements that if a company gets assistance from the federal government, it’s not allowed to undertake any stock buybacks for, I think it might be a year or so, if I remember the $2 trillion rescue package conditions correctly. Could you provide your view on stock buybacks, please, Dan?

Dr Dan Mitchell  26:12  

I wrote a column about this issue, I don’t know maybe a month or so ago, mostly because I wanted to express complete puzzlement as to why something like this has even become a big issue. What’s the reason to have a corporation? The reason to have a corporation is to bring together lots of investors to create a company that they own and that company then goes out and produces goods and services that are valuable, and then the company makes money. Well, where does that money go? It doesn’t go to the company. Ultimately, it goes to the shareholders. Now, if you own a pizza shop and you make more money from selling the pizza than it costs you to produce the pizzas, you’re making a profit. Where does this profit go? It goes to you as the owner of the pizza shop. Big companies and small businesses are exactly the same in this way. It’s just that we call the owners of big companies shareholders, and they work through this legal entity called the corporation. Now, how does a big corporation give profits to its owners to shareholders? Well, sometimes it does it through an ongoing regular dividend, but sometimes they decide to do a one-off dividend. And this became actually a big issue because when we did the big reduction in the corporate tax rate in the United States as part of the 2017 tax bill, that tax bill obviously reduced the tax burden on future profits, but it also reduced taxes on current profits, which are based on previous investments. So there was a sort of a windfall effect of that lower corporate tax rate, as well as an ongoing permanent effect of the lower corporate tax rate. So with that windfall effect from the lower corporate tax rate, companies, in effect, had a one-time influx of cash that they weren’t otherwise expecting to keep and what many of them did is they did stock buybacks. What are stock buybacks? You’re simply giving the option to existing shareholders to sell their shares back to the company, presumably at a premium because otherwise they wouldn’t sell the shares, so it’s a way of giving money back to shareholders that actually want to liquidate their position in the company, which then, of course, means they have now a pile of cash that they can invest elsewhere, so it helps the efficient deployment and allocation of capital in the economy. To me, it’s an utter non-issue. It’s sort of like me as a pizza shop owner, deciding, well, I got these additional profits, you know, maybe I’ll put it in my retirement account, maybe I’ll put it in my regular bank account. You know, maybe I’ll put it in my kids’ college fund or something like that. It shouldn’t be an issue for anybody to care about. However, having said all that, let me make two points where I think maybe government did play a role in all this. First of all, we’ve had years and years now of easy money policy, not just in the United States, frankly, in many other countries as well, and all that easy money means there’s a lot of capital sloshing around. When a lot of capital is sloshing around, it tends to mean that there are very low rates of return, and when there are very low rates of return, when companies accumulate cash because they’re making money, sometimes they don’t have any good things to invest in. If you have nothing good to invest in as the company, you might as well give it to your shareholders. And again, you can do it as a permanent ongoing dividend, you can do it as a one-off dividend, or you can do it via stock buybacks. Now, again, maybe there’s an argument there that we shouldn’t have easy money policy. Maybe there’s an argument that central banks haven’t been responsible, but there is certainly not an argument that companies are doing something wrong. One final point I’ll make on this goes back to Bill Clinton’s tax increase in 1993, which was actually really the only bad thing that happened during his eight years, other than that he was a pretty decent, market-oriented president. But of that 1993 tax increase, they put in a provision limiting the deductibility of compensation to senior executives. I think it was more than a million dollars a year could not be deducted against taxes, which in effect meant that not only did the executives have to pay tax on that income, but then companies also in effect levy a withholding tax on any compensation above $1 billion. But that law exempted a compensation that was performance-based. So, in effect, the tax law in the United States creates this big incentive to have performance-based compensation. That’s not a bad idea as a general rule, but one thing it does, it does give an incentive to do stock buybacks because that’s a way as you buy back stocks, and there are fewer and fewer stocks, that makes the remaining shares more valuable. So if we want to, to the tiny extent where this issue might be a problem, the way to deal with it is to address the underlying government policy mistakes that might be giving perverse incentives in the first place.

Gene Tunny  31:26  

Okay, Dan, that was really informative. I wasn’t aware of that Clinton era tax change and how that seems to be a major cause of the rise in performance-based compensation. That was really interesting. I have to look more into that. So, thanks for that. Dan, that’s been terrific, I’ve really found that illuminating. I’ve been enjoying your columns on Coronavirus, and I think that they’re well balanced, well reasoned, and one thing I’ll point out to listeners, and I’ll put a link to it in the show notes, I love that Venn diagram that you put on your blog, the other week, where you’ve got the three sets. You have people taking COVID-19 seriously, people worried about the expansion of authoritarian government policies, people very concerned about impending economic devastation, and you’ve got yourself at the intersection of those sets, which I think is the right place to be. It shows that it is just such a challenging policy issue to deal with because there are all of these competing considerations. I should ask finally, by putting yourself in the middle layer, are you suggesting that you’re probably one of the few commentators who you think are actually taking into account all those different considerations? Is that the point you’re making?

Dr Dan Mitchell  32:57  

In the United States, every time Trump says something about wanting to reopen the economy, you have some people demagoguing, saying, “Oh, he’s putting a price tag on human life”. Well, the reality is, everyone puts a price tag on human life. Anytime any of us get into an automobile, we’re taking a tiny, tiny chance that we might be in a car wreck and die. Anytime any of us have gotten on an aeroplane in our lives, we’re taking a tiny, tiny chance that we could die. So we make cost-benefit decisions all the time. Here’s a great example. There are in the United States, about 30,000 highway fatalities a year, car accidents, things like that. Well, if we had a national five mile per hour speed limit, presumably we wouldn’t have any traffic deaths. But we don’t do that because we know it doesn’t make sense from a cost-benefit basis. So, all throughout our legal system, our regulatory system, throughout scientific analysis, it’s very well understood by every single scholar that, yes, of course, we put a price tag on human life all the time. And obviously, if we keep our economy shut down forever, there’ll be a tremendous, cataclysmic, negative effect on the well being of people. As a matter of fact, the United Nations just put out a report that the economic damage from the coronavirus could wind up killing hundreds of thousands, if not millions of children. Primarily, of course, in very poor countries, because they understand that if you weaken an economy, you are having a negative effect on the health and well being and the longevity of a population. So, you know, I certainly don’t want to embrace every silly thing Donald Trump says, but I think he’s right. That, yes, of course, it’s in our interest, and not only in terms of GDP, but it’s also in the interest in terms of just the health and well being of the population to begin to have some economic production again because sooner or later if we have no economic production, we’re going to run out of money that the government can borrow and give us. People have to produce in order for us to have things to buy.

Gene Tunny  35:14  

Yes, the economic impact is just devastating. I’ve been just amazed at the 22 million additional unemployed people in the US in the last four weeks. It’s just extraordinary. In Australia, we’ve probably got another 1 million, we’re going to have unemployment rates at, you know, rates we haven’t seen since the Great Depression. It’s absolutely extraordinary. Dan Mitchell, you’ve been very generous with your time. Thanks so much for appearing again on the programme. And yeah, hope to speak with you again soon.

Dr Dan Mitchell  35:50  

Great talking with you, Gene. 

Gene Tunny  36:01  

Excellent. Thanks, Dan. We’ve reached the end of another economics explained episode. So thanks for listening all the way through. If you’re enjoying economics explained, please tell your family and friends and rate the show on Apple podcasts, Stitcher, or on whatever platform you are listening on. Finally, if you have any questions, comments or suggestions, please get in touch. My email address is Gene.tunny@gmail.com. Until next week, goodbye

 

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