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Should government bail out failing businesses?

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Should government bail out failing businesses?

Palatio home of one of the owners of businesses which are failing

Palatio home of one of the owners of businesses which are failing

The government of Uganda is warming up to release about 1.3 trillion shillings to bailout heavily indebted prominent businesses in the country. The source of this meant is of course the tax payers. The blessed companies include; Steel Rolling Mills, Roofings Limited, Grapes Construction and Ham Enterprises among others.

If cabinet approves this request the companies will be able to keep their heads above the water. This is not good music to the ears of the tax payers who claim that government ruthlessly continues to trim them off their money and don’t receive services in return.  This explains why such a decision has met open hostility from the public.

But Uganda may not be the first country to bail out companies swimming in bankruptcy.  A bailout is a colloquial term for giving financial support to a company or country which faces serious financial difficulty or bankruptcy. It may also be used to allow a failing entity to fail gracefully without spreading contagion.

A bailout can, but does not necessarily, avoid an insolvency process.   The government may take on ‘irrational ventures’ in the eyes of the public because government ought to be provident enough to predict the dangers associated with every situation in the country and therefore every move taken.

A bailout is required in some cases. Some companies are too big to fail, and they should receive government bailouts. But if, and only if, it can be proven that the company can be returned to profitability.

When a company employs tens or hundreds of thousands of workers in a single country, letting it go under the sea can have severe consequences to the economy and national morale. During the Great Depression and the economic crash of 2008, direct government intervention in the economy was necessary in countries like the US.

The car industry is an example of successful government bail-out IN USA. If major car companies had folded in 2008, the loss of jobs and general effect on the economy would have been stunning. By providing loans to prop up companies such as GM and Chrysler, many of those jobs were saved.

In addition, only a few years after facing bankruptcy those companies were on the road to recovery, paying back their loans and even thriving.  Government decision in this case was a genuine one.  For our case, we are starved with luck of conviction that our companies should siphon the tax payers’ money.

The biggest question is: To whose benefit?   May be government is paying back the tycoons for the role they played in bringing it back in power in the recently concluded elections.

If government successfully proceeds with this mission we are likely to face greater challenges. Bankruptcy does not mean the company disappears; it may just be owned by someone new.

Bankruptcy punishes those who took excessive risks while preserving those aspects of a business that remain profitable. In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime business activities. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This “moral hazard” generates enormous distortions in an economy’s allocation of its financial resources.

Critics of bailouts are aware that this signals lower business standards for giant companies by incentivizing risk, creates moral hazard through the assurance of safety nets and promotes centralized bureaucracy by allowing government powers to choose the terms of the bailout.

With bailouts in place firms can take reckless risks, and if the risks are realized, taxpayers pay the losses.  The spread of the moral hazard will then mean that the next crisis is much bigger. Why punish taxpayers for the financial indiscipline of business tycoons?

In bailing out failing companies, they are confiscating money from productive members of the economy and giving it to failing ones.

By sustaining companies with obsolete or unsustainable business models, the government prevents their resources from being liquidated and made available to other companies that can put them to better, more productive use. An essential element of a healthy free market is that both success and failure must be permitted to happen when they are earned.

This is not the case with bailouts. Instead the rewards are reversed. The proceeds from successful entities are given to failing ones. How will government identify genuine companies that need bailout?  Why is this exercise favoring companies that are already at the take off stage while abandoning small enterprises that are struggling to stand?

Is government aware that owners of such businesses requesting for bailout need lectures on financial discipline instead of bailout? It is obvious to most Ugandans need to reject corporate cronyism, and allow the natural regulations and incentives of the free market to pick the winners and losers in our economy, not the whims of bureaucrats and politicians.

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