Lemon Socialism vs. lemonade stand capitalism

Monday, 08 June 2009 10:33 Last Updated on Monday, 08 June 2009 10:35 Written by David Strom

No matter how often it fails, the allure of lemon socialism never seems to diminish.

Lemon socialism is an economic system where profits are kept private but losses—at least large losses—are borne by the society as a whole. Lemon socialism is so attractive because it often succeeds, for a while, in maintaining the illusion of a free market system and all its efficiencies while providing a level of security for workers and investors by foisting the cost of failure onto the society as a whole.

The reality, of course, is that lemon socialism is everywhere and always an unmitigated disaster for both the companies involved and the society as a whole. The sorry history of Britain’s auto industry is an object lesson in the dangers of lemon socialism. British Leyland—the nationalized auto industry that Britain dismantled in the 80’s because it failed so badly—is now a byword for failed industrial policy.

Here in America we have rapidly become the new home of lemon socialism.

Take the current bailout of General Motors. In just the past few months the government has poured about $20 billion into the company as bridge loans in order to prop it up during the financial crisis. That money—never appropriated by or debated within Congress—is now slated to be written off in GM’s bankruptcy. It will be gone. Kaput. Burned to ashes. Shoved down a rathole. Choose your metaphor.

As part of GM’s bankruptcy the government will agree to put in another $30 billion. To put that into perspective GM’s current long-term debt owed to bondholders is currently $29 billion and its market capitalization was less than $1 billion. So GM’s debt and equity were $30 billion, and in less than 8 months the government will have poured $50 billion into the company to keep it going.

See any problems with that? Apparently our overlords in Washington don’t.

Even a cursory glance at the AIG bailout shows that the GM disaster pales in comparison. After $180 billion in government bailouts AIG is still bleeding cash and customers. Would you want AIG as your insurer? Then why on earth would you want to own the company?

The huge financial firms that have been bailed out by the government are said to be “profitable” again, and we have even seen their share prices skyrocket since the government unveiled the “stress test” results. Of course what is left unspoken is the fact that almost nobody would want to own these companies but for the fact that we all can rest assured that should they run into continuing trouble the US Treasury will be there to bail them out. With the government promising to do whatever it takes to keep the banks alive and even profitable why not invest in them?

The government has half-nationalized these companies: taxpayers take the losses, private investors take the profits.

Lemon socialism can’t work for a simple reason: with no prospect of real failure companies cannot and will not do what it takes to be competitive. This damages the firms that are rescued—by reducing the risk of failure and the need to be competitive—and those that refuse government largesse—by advantaging their competitors with subsidies to keep them alive. GM and Chrysler will take market share that Ford would have seized had they been allowed to fail or forced to downsize to their competitive size.

Lemon socialism hurts everybody: the companies that take the government money, those that don’t, and of course and especially the taxpayers who are being forced to pick up the tab for all this mucking about in the market.

Businesses can only succeed if they follow the very same capitalist principles that a lemonade stand must: buy the inputs at a low price, add value in the most productive manner possible, and have an attractive product that customers want at a price they are willing to pay. And do so better than the kid next door. These are principles that we try to teach our kids when they open a lemonade stand, and these very same principles that should animate America’s largest companies.

Unfortunately our descent into being a bailout nation has subverted these very principles. Kids learn a very bad lesson if their parents are willing to subsidize their losses if they fail to run their lemonade stands properly—mom and dad will always be there to bail them out. American companies are learning the same bad lessons in today’s bailout friendly environment. If things turn south, expect others to pay.