05 August 2009

A Clunker of a Policy

The "cash for clunkers" program to encourage people to scrap their old cars in favor of a new one looks to be getting an infusion of new cash, taken straight out of DOE's stimulus package budget for energy innovation. If this isn't bad enough, the entire basis of the plan fails basic economics, as explained by Willem Butier:

Fiscal incentives to induce automobile owners to trade in their jalopies and buy new cars have been introduced in many car producing countries, including Germany, France, Italy and Spain. A number of US states and Canadian provinces also have introduced such schemes. The rationale is partly a general Keynesian demand stimulus, partly a sector-specific subsidy to workers, managers, share holders and creditors in the automobile industry and other industries that depend on them. If the programme is temporary and the cash incentive substantial, such programmes are bound to work.

This artificial shortening of the economic life of a car seems nuts. It’s worse than getting paid to dig holes and fill them again. It’s like being paid to burn down your house to encourage the residential construction industry. In Iceland, where economic calamity has befallen a population that was until the autumn of 2008 among the richest in the world, people torch their SUVs for the insurance money. Iceland doesn’t produce any cars, let alone SUVs, so this does not do their GDP any good, but think of the global externalities! Perhaps the G20 could propose the world-wide legalisation and subsidisation of the willful destruction of consumer durables, residential property and infrastructure (schools, hospitals, prisons etc.) as a global stabilisation policy measure. . .

If the replacement incentive is sufficiently short-lived, there need not be any long run effect on the level of car production, and even little if any effect on the (undiscounted) cumumulative volume of car production. A given cumulative volume of current and future car production would simply have its time-profile shifted from the future to the present. But if the scrapping subsidy were longer-lasting, cumulative car production would increase, resulting in greater environmental damage.

Cash for clunkers has both real costs and opportunity costs. The environmental costs vs. benefits are uncertain, however, a simple calculation using official figures indicates that the cost per ton of projected CO2 emissions avoided is about as much as $160 to $1,400, which makes it a bit difficult to accept Senator Diane Feinstein's claim that "This program has done much better than we ever thought it would for the environment." Maybe they thought that the costs would have been higher than $1,400 per tonne of CO2 avoided!

But even the projected figures are questionable because they assume that the new cars will be driven the same number of miles as the clunkers. Ken Belson at the NYT Wheels blog notes of the trade-in vehicles under the program:
The vehicles turned in were driven about 6,000 miles a year, he said. If the new vehicles are driven about 12,000 miles a year, the rough annual average, then consumers will actually use more fuel, not less.
If the shiny new cars get a more drive time than the old clunker, then it will result in more demand for gasoline. More broadly, lessons from Germany's experience with a similar program are worth keeping in mind:
Retailers, for example, have complained bitterly that the program sucks spending from other categories. German retail sales fell 1.5 percent in March -- the third monthly decline in a row -- a decline that retail industry groups blame partly on incentives to buy cars rather than other goods.

The rebate also is expensive. Nominally it will cost $6.6 billion if Germans take full advantage of the program. The real cost is harder to figure. Increased sales will boost sales tax revenues, and the state will avoid the cost of unemployment benefits for workers who might have lost their jobs. On the negative side of the balance sheet, the program will kill jobs in other parts of the economy, for example auto repair shops or used-car dealers.
Bottom line? Cash for clunkers fails basic economics and environmental tests, and in the case of the US it takes money from a program focused on investments in energy innovation. The politics of cash for clunkers should not lend anyone to optimism that far more complicated and far-reached legislation on cap-and-trade will be able to avoid such political trade-offs.