Is ‘Cash for Clunkers’ efficient?

CARS, more commonly known as “Cash for Clunkers,” was a government-funded rebate program that offered up to $4,500 to buyers who traded in older vehicles for new ones.  The program mandated that all trade-ins be destroyed.  Between July 1st and August 24th, nearly 700,000 eligible cars and trucks were traded in for new, more fuel-efficient vehicles, at a cost to taxpayers of just over $3 billion.[1]

Transportation Secretary Ray LaHood issued a glowing press release:  “Manufacturing plants have added shifts and recalled workers. Moribund showrooms were brought back to life and consumers bought fuel efficient cars that will save them money and improve the environment.”  He claimed the program “saved or created” 42,000 jobs, calling it “wildly successful,” “a win for the economy,” and “a win for American consumers.”  Was it?

Bureaucrats always defend their spending programs by offering up some number of jobs they’ll create or production they’ll stimulate.  But if more jobs and higher sales are all that’s required to generate “a win for the economy” then surely it would have been an even bigger win had the government handed out $6 or even $66 billion.  $66 billion would not only help auto makers add even more shifts and recall even more workers, but would require the construction of entirely new plants!  Why settle for only 700,000 when 10 million new cars could be produced and sold?  And yet, it seems obvious that borrowing another $66 billion from the Chinese to finance the production of 10 million cars nobody wants isn’t the most effective way to promote economic recovery.  Clearly, something’s missing from LaHood’s analysis.

The science of economics demonstrates that subsidies are wasteful because they induce overproduction of the subsidized good at the expense of more valuable alternatives.  The reason why just so many units of a particular good are produced in the free market is that consumers value additional units less than the cost of producing them.  Firms that try to produce more than the market will bear suffer losses.  The losses cause firms to cut back production, freeing up resources which can then be used to produce other, more valuable goods.

Subsidies prevent this important market adjustment from taking place.  The $2.8 billion the government borrowed and doled out for new cars would have been saved or spent on other things.  The 42,000 jobs LaHood claims were “created or saved” came at the expense of jobs lost or never created in other industries.  700,000 new cars were manufactured at the expense of other, more valuable goods that would have been produced had the necessary resources not been redirected.  The exact amount of the loss depends on the shapes of the supply and demand curves; the more sensitive sellers and buyers are to price, the more waste the subsidy will generate.[2]

The misallocation of scarce resources isn’t the only waste generated by the program.  Society also loses the $300 million handed out in administration fees.  But perhaps the most damaging aspect is the mandate that all traded vehicles be destroyed.  Not only does Cash for Clunkers guide resources to the wrong industries, it robs us of hundreds of thousands of perfectly functional cars and trucks.[3]

The fact that the newly purchased cars get better gas mileage in no way mitigates these losses because the costs and benefits of improved mileage were already factored into consumer demand.  Before the subsidy, the typical clunker owner compared the benefits of better fuel economy with the costs of financing a new car and decided it wasn’t worth it.  Forcing him to buy it makes him worse off.  Forcing taxpayers to pay for it makes him (and the seller) better off, but not by as much as everybody else is made worse off.

The only potential benefit over and above the market outcome is a slight improvement in air quality.  However, seeing that the EPA already sets limits on vehicle emissions, including clunkers (which must pass yearly inspections), we can assume that any additional improvements in air quality realized as a result of Cash for Clunkers are unnecessarily costly.

Interventionism diverts capital from high quality, low cost producers to less efficient but better connected competitors.  Instead of seeking out companies that deliver value, investors try to ascertain which companies are better at using the power of government to secure taxpayer dollars and regulate away competition.  The effect is declining productivity and a lower standard of living over time, all so politicians can secure thousands of votes from favored industries.  Given the hundreds of millions in contributions Obama has received from labor unions, along with his promises that taxpayers won’t lose money on the government’s 61% stake in GM and 8% stake in Chrysler[4], Cash for Clunkers appears particularly self serving.

The November 24th, 2008 cover of Time Magazine depicted Obama as a modern-day FDR.  The FDR administration was so economically backward that, at a time when millions had to stand in line to get a decent meal, they thought paying farmers to destroy crops and slaughter hogs was a way out of the Great Depression.  Now the Obama Administration is using taxpayer money to purchase and destroy hundreds of thousands of working vehicles as a way out of the current recession.  Maybe Time was right.

Notes

  1. Despite Congress having to allocate another $2 billion for the program after the first billion was gone in a week, the Transportation Department keeps patting itself on the back for coming in “under budget”.
  2. The increase in manufacturing activity mentioned in LaHood’s press release suggests supply is fairly price sensitive.
  3. The deadweight loss and loss due to capital destruction can be captured diagrammatically:
    How the subsidy affects the clunker market
  4. To date, the government has spent more than $81B bailing out the auto companies.
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