Sunday, August 02, 2009

The Cash for Clunkers "success" story: Crow about it? Or weep and cry woe over it? 

The government's "Cash for Clunkers" "Car Allowance Rebate System (CARS)" program, that provides up to $4,500 towards the purchase of a new car when trading in an old, low-gas-mileage "clunker", has proved so popular it has exhausted its $1 billion of funding in just its first week of operation.

"This is simply the most stimulative $1 billion the federal government has spent during the entire economic downturn," Rep. Candice Miller, R-Mich., Miller said Thursday. "The federal government must come up with more money, immediately, to keep this program going." [NYP]
And Congress is already is providing $2 billion more, to keep the program from being suspended.

But while the program certainly has proved popular, is it really such a simulative success to celebrate?

The gist of how it works (as per is: You bring in to your dealer a car you currently own that gets 18 miles per gallon or less, buy a new car that gets 10 miles per gallon more than yoiur old one, and receive from the government a credit of $4,500 against the price of the car you buy. Or if you buy a car that gets four-to-nine miles per gallon more, you collect a credit of $3,500. The car you brought in is then destroyed by the dealer, so it never drives around on the highway guzzling gas ever again.

Obviously that sounds very good to a lot of people! But after considering a few issues for a few moments, one's judgment may adjust....

1) Who gets how much credit -- and who pays what cost?

All the publicity says "you" the consumer get the $4,500 (or $3,500) credit, but it is actually paid to the dealer, not to the car purchaser. You, the purchaser, negotiate the best price you can for the new car, just as you would otherwise, then get the credit against that price.

This is important because knowing the value of the credit the dealer can raise the price to snag some or most of the credit for himself. (Just as dealers do with the hybrid car tax credit). And the dealer is dead certain to do just that.

Don't be so naive as to think that when you bring your old car into the dealer you'll get both the value of a trade in and the credit -- a mistake that many apparently are making, contributing to the flood of credit seekers. The credit replaces trade-in value (because the dealer, after destroying the car you bring in, has nothing to resell.)

Thus, in price negotiations, the first thing the dealer is going to do is subtract the full trade-in value of the car you bring in from the credit, taking all that amount for himself. Then he'll negotiate sharing the rest of the credit, if any, with you.

Example: You have an old car with a trade-in value of $4,000 -- but, you think, why settle for that when you can get a credit of $4,500? You have your eye on a new car with a market price of $25,000. With a $4,000 trade-in you could buy it for $21,000 cash. But with no trade-in, the dealer is going to charge a full $25,000 cash. To get the cash price back down to $21,000, the dealer has to take the first $4,000 of the "clunkers credit" for himself. After that, there's $500 of the credit left over. To be competitive, the dealer may give you say 60% of that, $300, keeping $200 for himself, and knocking the cash price of the car down to $20,700.

Verdict: Cash-wise, compared to a conventional trade-in, you make $300, the dealer makes $200 ... and taxpayers pay $4,500! So it's a modestly nice little deal for you as a car buyer, and for the dealer. But you, the car buyer, are a taxpayer too -- and cost-benefit wise, getting $300 (or even $500) for a cost of $4,500 is horrible.

2) How stimulative is it?

Most people who bring in a "clunker" now to get the credit for it would have traded it in during the foreseeable future for a new car anyhow. So while the "clunker credit" will produce a big surge in new car purchases for a few weeks, which looks "highly stimulative", most of those sales come at the cost of fewer new car purchases earlier and and later.

Note the bust in car sales that followed an initial boom triggered by a cash-for-clunkers program in Germany. And as to car sales here in the US: "The decline in June versus May stems from two factors. First, the passage of the CARS Act (cash for clunkers) by Congress likely kept many consumers on the sidelines..." [NADA]

This is a well known drawback of temporary "investment credits" enacted for business -- they result much more in businesses timing investments to get the credit than in making additional investments that they wouldn't have made without the credit.

Verdict: For car makers and dealers the timing shift is modestly beneficial, on the principle that getting income from car sales now, during the bottom of a recessionary sales slump, is better than getting that income later. But for taxpayers, paying a tax cost of $4,500 merely to shift the timing of a car sale that would have occurred anyhow is terrible.

3) Destroying 750,000 functioning cars -- good or bad?

The "green" selling point of the "clunker credit" is that the old cars brought in are destroyed so they won't consume gas ever again. But is this really good? To tell, one must measure the touted benefit against the social-economic cost of the destruction -- a very real cost rarely mentioned.

The "green" benefit of this program is so small (if it exists at all) that as of this writing I haven't been able to find anyone who's tried to quantify it in the US. But there are several European examples of such programs that have been examined -- and the findings are not good, to the point that even European environmentalist groups have come out against them.

For instance, Britain's Environmental Transport Association says...

“Car scrapping schemes are good for boosting new car sales – they have very little to do with the environment and to suggest otherwise is not just greenwash, it is hogwash.” [ETA]
... in urging protests against car scrapping schemes.

So the net eco-benefit is faint, if there is any at all. But the cost is very real -- the destruction of billions of dollars worth of functioning, useful automobiles.

Here there's a need to address a larger issue for a moment: It is a common, perversely seductive belief that destruction somehow can be economically beneficial. Examples abound...

[] During the Great Depression, New Deal policies forced farmers to destroy chickens and livestock and leave fields unplanted to increase farm prices. (Good if you were a farmer, but not so good for poor people who needed to buy food.)

[] Newspapers commonly report that hurricanes and earthquakes will help local economies by "boosting GDP" through the rebuilding efforts that follow.

[] Twenty years ago many American businesspeople complained that Japanese industries had an unfair competitive advantage in that their plants had been destroyed during World War II while ours hadn't, so their plants were newer.

[] Paul Krugman after the 9/11 attacks wrote: "Ghastly as it may seem to say this, the terror attack ... could do some economic good ... Now, all of a sudden, we need some new office buildings."

And so on ...

But this belief is totally false. It is the "Broken Window Fallacy", memorably illustrated by Frédéric Bastiat near 160 years ago in his parable of the broken window.

Bastiat told the tale of a shopkeeper whose window was broken by a delinquent stone-throwing youth. At first, everyone felt sorry for the shopkeeper -- but then they saw the income the glazier received for replacing the window, and how it was soon spread by the glazier to the baker, the shoemaker and the town's other shopkeepers, and through them to the entire community, making all richer. And so the boy came to be seen not as a vandal but as a benefactor of the community.

The fallacy lies, of course, in the facts that (1) the loss to the shopkeeper offsets the gain to everyone else, and (2) the money the shopkeeper spent on replacing his broken window, to merely restore its prior condition, otherwise would have spent by him anyhow on something else, improving the condition of the community. So the community is left unambiguously poorer by the destruction of the window, with no increase of income to offset it.

This all becomes self-evident if you simply scale up the window-breaking. If breaking one window makes the community a little richer, then everyone should voluntarily break all their windows to become a lot richer. And why stop there? Why not burn the entire town down to the ground, to become richer yet from rebuilding the whole place, and end up with a new and better town too?

The Cash for Clunkers CARS program is based solidly on the Broken Window Fallacy. It will destroy about 750,000 functioning cars with positive market value on the premise that this will be good for the economy.

But what will the economic effect actually be? To see, once again we can imagine doing the same thing on a much larger scale -- imagine, say, the government mandating the destruction of two years' worth of trade-in vehicles, about 20 million.

Now the effect becomes self-evident. With the nation's supply of cars reduced by 20 million the price of cars, both new and used, shoots way up. This is great for auto manufacturers and for dealers with existing stocks of used cars. But for consumers who need to buy a car it is terrible. And it is regressive -- most harmful for low-income individuals who can't afford an expensive car, and for families that need a low-cost second car for a member to drive to school or to a family's second job, and so on.

And with the government overpaying for each car above its market value by as much as it is now, the cost of the program becomes at least $80 billion -- an average of $1,000 for each of the US's 80 million taxpayers -- probably much more.

And, yes indeed, with the price of cars shooting way up due to the destruction of 20 million of them, and that entire overpayment in that $80 billion-plus footed by taxpayers forcibly being spent on the purchase of new cars, of course the Michigan Congressional delegation thinks this is even better than "the greatest stimulus ever"!

But if you ever want to buy a new car outside of this program, or you want to buy a used car, or need a low-cost clunker, or you are a taxpayer ... not so good for you!

And this effectively is exactly where we are today, except on the scale of "only" about 750,000 to-be-destroyed vehicles.

Behind a "green" fig leaf -- an embarrassingly small and thin one -- that many cars, worth perhaps $1.5 billion dollars (an average of about $2,000 each) are being removed from the market, increasing the market price of all cars for the benefit of Detroit, with Congress having taxpayers pay about twice their market value, $3 billion (an average of about $4,000 each) for them.

If those 750,000 cars had been normally traded in, they would have remained in the market, available for use by those who need them, reducing the price of all cars for all consumers, and saving taxpayers $3 billion.

Final Verdict: Now we can tally up the winners and losers of the Cash for Clunkers CARS program...

Big Winner: The auto industry, as it gets another cash subsidy from taxpayers, accelerated sales, and higher permanent prices due to the reduced supply of cars.

Small winners: Around 750,000 persons who, over the course of about one month, will buy cars using the program and obtain some modest purchase-price benefit from the credit.

Small losers: All the millions of other car buyers, now and into the future, who will pay higher prices due to reduced supply. And though their individual losses may be small, over the millions of people affected they will add up.

Big losers: All taxpayers, who get to pony up the cost of yet another multi-billion-dollar auto industry bailout.

The financial net is that taxpayers are paying $3 billion to destroy about $1.5 billion or $2 billion worth of productive assets. (Can anyone think of a better financial policy than that?)

Yes, the CARS program is a bigger success than anyone expected! Cheer or cry about it, you decide.

I'm located nearer the weep-and-woe end of the spectrum, as you may have guessed. But my consolation is that in our world of a trillion dollars spent here and another trillion spent there, a mere three billion is more baby peas than even small potatoes. (If someone were to bring up the other $784 billion of the Obama "stimulus" program I might get more upset.)

However, the Broken Windows Fallacy has once again become official national economic policy, here and throughout the Obama stimulus package, for all to see.

That may be the most important development of all.