Government Motors

Quick economics quiz, GM made a lot of big SUVs because:

A) They hate the environment
B) They don't know how to make small cars
C) SUVs were easiest to sell
D) SUVs have a higher profit margin
E) Both C and D

The answer is E. GM preferred selling SUVs because those were the only vehicles that GM actually made any money on but they were also a popular choice among car buyers. Even in today's economic downturn, SUVs continue to outsell other segments of the market. The big exception to this was the demand for hybrids last Summer when gas topped $4/gallon. GM's upcoming super-hybrid Volt will not make any money, at best they will break even on it.

The reasons that GM only made money on SUVs are complex involving outmoded plants and high labor costs. It is unclear how many of these factors will be addressed by the bankruptcy. It is unlikely that GMs costs per vehicle will be reduced enough to make smaller cars profitable.

President Obama knows this. He is a smart guy and has smart economists advising him. So why did he announce that GM would be making smaller, more fuel efficient cars in the future? There are a couple of possibilities:

A) He doesn't care if GM fails.
B) He plans on doing something to change demand.

This goes beyond economics and into politics so either is possible. Obama is a believer in global warming as are most of his supporters. Many of them ignore what has been selling and are convinced that small cars will sell. Obama might be placating these people, knowing full well that GM will continue to need government bailouts but not caring.

The other possibility is that the Obama administration is planning a set of policies that will change consumer demand. Last Summer's spike in gas prices caused a temporary demand for hybrids and scooters. In the near future either Congress or the EPA will be taking action to reduce CO2 emissions. This is likely to include some form of gas tax which could make SUVs too expensive to drive. Obama has been open to this. Last Summer he said that the problem with the gas prices was not how high they were, it was that they had risen so fast that people had not had time to adapt (by buying smaller cars?).

Other questions arise. GM and the other two Detroit car makers have already asked for more money to retool to meet new CAFE standards. How much aid will the government continue to give GM and is this fair to other car-makers? Will a government stake in GM mean that they will do whatever they are told or will that give them priority when lobbying?

When the government has an interest in an open market things get messy.