Iraki: Why bailout of ailing State firms is counterproductive

The tail of a KQ plane, JKIA, March 2020. [Edward Kiplimo, Standard]

A story in the local media quoted a government official suggesting that the government should bail out universities the same way it has bailed out tea and sugar cane farmers as well as Kenya Airways (KQ).  

This got me thinking: Should we bail out firms in distress or let them die? This is an emotional question given that the death of a firm means job losses and distressed families.  

Why do governments bail out ailing firms either by giving them money directly or by offering subsidies?

Why not let the market decide their fate? Subsidies can include firms selling their goods and services below cost and the government topping up to make them appear profitable.

Giving firms monopolies or raising tariffs to keep off competing products are other forms of subsidy. Add interest-free loans or even government guarantees. 

But why are bailouts popular? The key reason is that they are political. If the struggling firms are allowed to die, the political cost would be too high.

Closing sugar factories would leave many farmers in distress and lots of votes lost. The same would apply to khat or coffee farmers.

The Kenya Airways case is a bit different. It would dent Kenya’s national image and make the country unattractive to investors.  Let’s not forget that each firm is interconnected to others both locally and across the borders.

For example, KQ has leased planes, has code-sharing deals with other airlines and has suppliers for such products as food, spare parts and fuel.

All these supply chains would be hit by job losses. The government sees the bigger picture in the form of the votes and possible instability if too many people are rendered jobless. The bigger question is why taxpayers’ money is used to keep unprofitable firms in business.

A Kenya Airways plane. taking off at the JKIA, September 2019. [Edward Kiplimo, Standard]

The overlooked reason is that the government seems to have lots of money because it’s “pooled”.

Two, the men and women who decide on bailouts are impersonal; it’s not their money.

They know it’s tax or debt, but who sweated for it is not their problem.

They often focus on bailouts with the highest returns in terms of votes. Check which sectors got bailouts in the last 20 years geographically. 

What of economists? In a market economy, which we claim to be,  the invisible hand of the market should be allowed to do its work.

If your products or services are in demand, you thrive and grow. If not, you close shop and let others expand into your market.

If a supermarket closes because it’s inefficient or mismanaged, we should let it close and let others take over.

Keeping inefficient firms is costly to the economy and consumers. They pay more than the market prices.

The wrong people bear the cost of inefficiencies. Resources are deviated from possibly more productive to less productive sectors.

This is what makes bailout attractive to politicians - they can reward some people at the expense of others.

Unprofitable firms keep jobs but destroy others which would have been created by the expansion of the remaining ones if they are efficiently run. 

Sometimes the government can bail out a firm to ensure competition in an industry and tame monopolies. 

Do you remember when we had only one telephone company? It took me two years to get a phone line in my house.   

The economy loses through bailouts by discouraging innovations too. [Courtesy]

The reasoning is that governments bail out firms to give them a chance to reform and get back to financial health.

In the West, they talk of bankruptcy protection. Given their importance to voters, it’s easy for such firms to become addicted to bailouts.

It needs very bold political decisions to stop, maybe at the start of a political term. Bailouts are like first aid; the patient must later go to the hospital for medical check-ups, which could lead to surgery or death.

By refusing to take firms to economic hospitals, we fail to prepare them for economic deaths.  

The economy loses through bailouts by discouraging innovations too. Some of the firms are victims of innovations.

Think of companies that made money from fixed phone lines after mobile phones. Think of the disruption electric cars will cause.

Through bailouts and subsidies governments often try to stop Schumpeter’s gale of creative destruction that shows how innovation is creative and beneficial, bringing new industries, wealth and unique employment opportunities.

It is, however, destructive of some established firms, many products and jobs, and the dreams of failed entrepreneurs. Bailouts make political sense but no economic sense.

How shall we expand our industries if they are protected from competition?

How shall we boast of homegrown multinationals if we can’t allow our firms to compete?  

Finally, if we can import the American political system with some spicing from Nigeria (commissions), why not their economic system, particularly their market system peppered with the Protestant work ethic?