Paul Krugman links to a good article by Brian Palmer (“How Did Detroit Become Motor City“), which describes why Detroit became the center of the American automobile industry after the 1920s. At first, Detroit was dominated by Ford, which invested heavily in research and development. Slowly, other companies began to come to Detroit, and over time these companies and their suppliers developed a knowledge management system, becoming heavily interdependent. It just made sense to operate in Detroit, since otherwise you would be excluded from an already existent automobile-centered structure of production.

Krugman (“Motor City Stories“) mentions that this fact was heavily considered when Washington D.C. decided to bailout General Motors. Had GM fallen, so would much of the supply system, and other auto companies would have suffered as a result. Krugman warns that these types of rationales should not be abused of, but one gets the impression that, in the case of Detroit, Krugman is considering it a good thing.

I question the truth behind the claim that the bankruptcy of GM, without bailout, would have doomed the auto industry. As was shown in the aftermath of the crisis, foreign auto companies were willing to invest into and pick up the healthy pieces of some of the smaller manufacturers connected to GM, and Chrysler saw heavy invested from Fiat. Many of these companies saw a change in management, in other words, and this part of the demand for automobile inputs would have remained. Even otherwise, I do not see why the supply chain would not shrink only to the point equal to the new demand for its products. In short, I am not so sure that this event was as much of a crisis as Krugman makes it out to be.

Also, entrepreneurial failure is not a purely negative phenomenon. Loss transmits important information to other entrepreneurs. It shows what entrepreneurial strategies are ineffective. It gives other capitalists an idea of what not to do. In this sense, loss can be just as a valuable as profit. I would go as far as to say that loss is both a force of discoordination and coordination.

Additionally, let us suppose for a second the possibility that the entire auto industry would have collapsed without the bailouts. So what? Some of the producers’ goods, perhaps, would become useless (and, thus, cease being economic goods). Many of these resources, however, would have been redistributed towards the production of more highly valued goods. For Krugman to justify the bailouts, he would have to make the case that the outcome of the bailouts is preferable to the outcome which would have existed otherwise.

One could make the argument about the marginal efficiency of capital, long-run expectations, the rate of interest, and/or the fear of deflation, but I still do not think any of these would justify bailing out General Motors. Even if the theoretical argument behind why we remain in a slump is correct, there are means of promoting a recovery without directing the use of capital (and, yes, a bailout is directing the use of capital, since you are explicitly attempting to prevent its redistribution).