Posted tagged ‘Congress’

Is ‘Cash for Clunkers’ efficient?

October 6, 2010

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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What government stimulus stimulates

February 18, 2010

It might come as no surprise that the Obama-Reid-Pelosi stimulus bills have been colossal failures. What might surprise you, however, is that sound economics demonstrates no other outcome is possible.

In a free market, consumer spending patterns determine the array of goods and services produced. Changes in consumer preferences cause changes in relative prices, which in turn give rise to profit opportunities. Businesses take advantage of these opportunities by cutting back the production of relatively lower-priced goods in favor of relatively higher-priced goods consumers now prefer. Competition hastens the adjustment process, promotes efficiency, and drives down prices.

Stripped to its essentials, the market can be thought of as the process in which producers, guided by price changes, continually adjust the allocation of resources in order to supply the mix of goods and services that best satisfies consumer demands.

In February 2009, Congress passed, and President Obama signed into law, the “American Recovery and Reinvestment Act” (ARRA): an $862B “stimulus” bill ostensibly crafted to rescue America from recession. The bill authorized about $500B of new spending through 2012.

Cash for Clunkers” (CARS), was a government-funded rebate program that offered up to $4,500 to buyers who traded in older vehicles for new ones. During the summer of 2009, nearly 700,000 eligible cars and trucks were traded in, at a cost to taxpayers of just over $3 billion.

In August of 2010, Congress authorized another $26B in new spending to stimulate the hiring of teachers and administrators.

How do these kinds of spending programs affect the economy? What exactly do they stimulate?

Vote buying and influence peddling

When government announces $500B in new spending, unions, corporations and other special interests will try to secure a slice of the pork by increasing their lobbying expenditures and political contributions. The bigger the stimulus, the more money will be spent buying influence and the less will be available for investing.

In union-dominated industries, unions will attempt to capture stimulus dollars directly because they are better positioned than corporations to reap the lion’s share of the haul.

The transfer of wealth from ordinary citizens to special interests

In 2008, unions gave about $75 million to federal candidates and parties, with about 92% of it going to Democrats. Although unions make up only about 12% of U.S. workers, roughly half of all stimulus spending authorized under Obama will flow through union-controlled entities.

Unions extract above-market wages by restricting the labor supply. The rise in labor costs chokes production and raises prices. Stimulus-induced increases in union compensation come at the expense of non-union labor, in the form of lower wages, and consumers, in the higher prices they must pay for union-manufactured goods. Union members enjoy million dollar pensions not because they’re more productive, but because they provide money and votes to politicians who pass stimulus bills.[1]

Wealth is transferred to other special interests and favored constituencies in similar fashion, and with equal effect:  society becomes less productive as more and more resources are allocated by government instead of markets.

Goods and services nobody wants

There’s a reason why so few solar panels and wind turbines were manufactured before government started subsidizing them–they’re economically wasteful. (The same might be said of $100k puppet theaters.) Despite this, the ARRA allocates billions in spending for these and other, equally wasteful initiatives.

Stimulus spending undermines the market process by shifting the focus of production away from goods and services consumers actually demand to stuff Obama, Reid, and Pelosi cherish, like electric cars, or are paid to protect, like union-controlled public education. In a free market, the profit motive serves as a powerful incentive for businesses to produce goods that are more highly valued than the resources used to produce them. Stimulus spending encourages the opposite.

The free market has made production possible on a scale once thought unimaginable. Stimulus programs, on the other hand, promote cronyism over competition, stagnation over progress, and waste over efficiency. The only thing they truly stimulate is our gradual impoverishment.

Notes:

  1. And, more importantly, to politicians who craft pro-union legislation.

Further reading:


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