Paul Deets is a brilliant mechanical engineer and has designed a car that will give the other car companies a run for their money. He got his MBA son to write up a business plan and has financing from banks just waiting for him to pull the trigger.
He calls in favors from his other engineer friends and some that graduated from college with him that want in on this venture. This group isn’t a dream team but they are smart, prepared and determined to make this work.
He has a date: August 1st. He gets all the required paperwork done to start his business and finds the perfect spot to start: an abandoned Chrysler automobile assembly plant. He may even be able to use some of the equipment they left behind! Paul and most of his engineer friends are working for nothing with a promise of a piece of the company once the money starts coming in. Now all he needs is the capital to buy the abandoned plant, get the equipment, office support staff, computers, telephones, etc.
August 1st is just two months away and he goes to the three banks where he’s arranged financing to start.
Bank #1: Paul, I’m sorry…but we’re going to have to pull the funding we negotiated last month. Our finance committee has just notified us. I can’t tell you how sorry I am; I know you’ll make it and I hope you’ll forgive us and me personally. I really believe in you.
Bank #2: Mr. Deets, I’m afraid we’re going to either have to re-negotiate for a higher interest rate on your capital loan or cut the amount of the loan in half. “But…why?…Make me understand why your bank is doing this?” Mr. Deets, I’m sorry…if you want to discuss this you can make an appointment with the chairman of our loan committee to discuss it. Are you willing to re-negotiate the terms? “I can’t answer that until I discuss it with my colleagues. Good day, sir.”
Bank #3: Paul…we’re not going to lend you the money. “What the hell is going on here, John? We’ve known each other for 12 years now…and two other banks have pulled their offers! What the hell is going on here? Please tell me and help me understand…I promise I won’t hold it against our friendship…I just need to figure out why I no longer have the resources I need to start!” Well…I’ll tell you Paul: You have a great design, you have a great team, you have a great business plan but you don’t have the money because the money you negotiated for is going to GM and Chrysler to bail them out.
And here’s the splinter…the IDEA that I need you to walk away with today: Economics is the study of the use of scarce resources which have alternative uses.
The consequences of bailing out the big and bloated car makers and their unions forced the banks to make a rational decision to put their limited resources (in this case, money) in a “sure thing”…a government guaranteed promise that the loan will be paid back with interest.
The banks made a rational decision: Would you gamble 5 million dollars on a 60% chance of the new car company making it or the 100% chance that you’ll get your profit by bailing out GM & Chrysler? But until the government stepped into the situation, the banks were willing to do JUST THAT: Gamble 5 million dollars on what looked like a good deal until the “sure thing” short-circuited everything.
Just what does ‘scarce resources that have alternative uses’ mean? What everyone wants always adds up to more that what is available. That’s what is meant by scare resources. Alternative uses means that money and the resources it will buy could have either gone to Paul’s new company or to GM & Chrysler.
Another real world example would be when our corn crops are funneled by our government to go to the production of Ethanol to add to gasoline. Where would that corn have gone if the government hadn’t diverted it? It would have made the thousands of products that they make from corn to sell here in the U.S. or in trade with other countries. The result is higher prices for all of the products made with corn directly and indirectly. Corn for use in animal feed, food products and thousands of other products is now more expensive because there is less of it to go around…it is scarce.
In the case of Paul’s car company that will never-be: The government chose to give our money to failing car companies because of their “friendship” with the United Auto Workers (UAW). What would have happened if the government hadn’t interfered with the natural course of ‘free enterprise’ that Paul was exercising? We’ll never find out. And that’s the tragedy of government interfering with free markets: Saving the big, bloated, inefficient car companies makes the government look like heroes to people who don’t think beyond the initial stages of a situation. We’ll never see that Paul’s new car designs were the “iPhone” of their time and because we never see that headline, it never really happened, now did it?
Soon, we’ll discuss “Too big to fail” and the economic principle that dictates that if we’re going to have a healthy economy, they MUST fail.