Thursday, April 30, 2009
Sunk Costs in Detroit
Something tells me that I will be able to write a great (but sad) paper several years from now about the sunk cost trap as it pertains to the federal government and the U.S. automobile industry. The sunk cost trap refers to the tendency for people to escalate their commitment to failing courses of action in the face of high sunk costs, i.e. to throw good money after bad. I fear that we will continue to engage in this type of escalation over time in Detroit.
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When the auto industry first went for bailout money do you think they did so with an understanding of politicians tendencies to throw good money after bad. What I mean is do you think the auto industry gave low estimates of how much aid they would need understanding that once they got initial funding politicians would likely give more (due to sunk cost trap)?
All of the attention that is being focus on how terrible of a situation Detriot is in will ultimately help. The pessimism that everyone is feeling should lead to optimism. Even the UAW has signed on to the doom and gloom. My opnion is Chrysler will fail miserably, however Ford will be king and GM will just hang on. In talking about the Auto Industry as a whole, Tesla will be noteworthy in the future.
I think the companies definitely understood that once they got the government involved, it would be hard for Uncle Sam to turn off the spigot.
In economics their is a concept of external economies of scale which occurs when the cost per unit depends on the size of the industry but not necessarily on the size of any one firm. An important element of this concept is the geographic concentration of an industry. According to Paul Krugman, "A geographically concentrated industry is able to support specialized suppliers, provide a pooled labor market, and facilitate knowledge spillovers in a way that a geographically dispersed industry cannot". Examples include Silicon Valley's high tech industry and Detroit's Auto industry. My question is will the surviving firms in Detroit's auto industry suffer from the failure of other firms (Chrysler bankruptcy)? As the industry shrinks it seems logical that Detroit's external economies of scale benefits will diminish.
There will be some detrimental impact on the other automakers if, for instance, Chrysler was to simply be liquidated. However, we have to remember that there is a very large American auto industry that isn't in crisis... namely, the Japanese automakers who have extensive American manufacturing facilities in the Sun Belt and South.
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