Wednesday, August 5, 2009

Cash for clunkers

The Cash for Clunkers program that ran out of money after just a few days in operation is an interesting program from many perspectives. It is firmly in the tradition of some of the New Deal Programs--it immediately brings to mind the agricultural program that paid farmers to kill livestock. It seems to have a considerable amount of political appeal because it seems to be effective.

I have not read economists on the program, but I am confident most of them, other than some of the extreme partisans, would give it thumbs down. Economists have certain criteria by which they evaluate programs. One of them is equity or fairness. Who does the program benefit? The problem that this program has from an equity point of view is that it seems largely arbitrary. It is as if the government held a lottery and gave random people several thousand dollars. To qualify, one must have an car that has low value. Lots of lower and middle class families have those, often as a second or third or fourth car. I do not know enough about the rich to know if they tend to have old clunkers. Then one must be willing and able to buy a new car. For some of the poor, that may not be an option--they will not be able to make the payments. As time goes one, someone will figure out if this program subsidized the rich, the poor, or the middle. My guess is that it was a subsidy that went largely to the middle--or to the dealers, who were able to charge higher prices because of the program.

A second criteria is efficiency, which asks the question of whether the program increases value. Here the program is clearly a disaster because it destroys things that have value. The cars traded in with the program must be destroyed, as must their parts. The program is taking a lot of cars that are worth a couple thousand dollars each and converting them into scrap worth a few hundred dollars each. This brings up a secondary equity point. For many of the poor, the purchase of used cars is their best option in getting vehicles. This program will tend to raise the price of older used cars because it reduces their supply. The poor will pay more, and most economists believe that programs that hurt the poor should be condemned on equity grounds.

However, are these bad effects worth enduring for the good of stimulating the economy? We can see that sales of autos have greatly increased as a result of the program--so much so that the program ran out of money after just a few days in operation. A key question here is to what extent were those sales new sales, sales that would not have taken place without the program, and to what extent were those sales simple shifted in time. If you wanted to buy a new car and had a car that qualified as a clunker, you would have had a strong incentive to wait until the program was in force. Or if you were planning to buy a new car sometime in the future, you would have had a strong incentive to move the purchase forward in time to take advantage of the several thousand dollar grant. It is not clear that the program did more than shift sales in time, and if that was its primary effect, it was meaningful stimulus.

Addendum: People find ways to game the system, another example of people responding to incentives.

Update: Econbrowser had a post on the program with many comments.

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