Cash for clunkers

Alasdair Macleod – 7 August 2009
The distorsions created.
Governments routinely try to steer the private sector towards a political objective, and we are all so used to this that we no longer bother to question the overall effects of government intervention. This is an important point, which is totally missed by Keynesians and monetarists, who provide the intellectual justification for the “management” of the private sector. These bad economists only consider the immediate effects; the good economists look at the indirect and long-term consequences as well.

For our sermon today, we will look at something we can all agree is reasonable on the basis of the immediate objectives: encouraging people to dump smelly old petrol-guzzling polluting cars in return for environmentally better new ones.

The UK government has a scrappage scheme to pay £2,000 to scrap cars over ten years old, in the form of a subsidised discount on a new car. The US now has a similar scheme dubbed “cash for clunkers”, and various other countries also have similar schemes. The reasons are all the same. These schemes are designed to rescue the motor industry, from manufacturers to forecourt salesmen, and they have an environmental benefit. The objectives are sensibly political but uncontentious – until you think it through.

Firstly, we need to question the need to subsidise the motor industry through intervention in the market. There is obviously over-capacity in car manufacturing, which was encouraged by freely available consumer credit before the credit-crunch; over-capacity that is now starkly exposed.
People do not need new cars, because old ones are now more reliable and do not rust like they used to. So after the credit crunch the market for cars is fundamentally different, and scrappage schemes interfere with the market process whereby supply and demand finds its new equilibrium.

Politicians do not want to understand this, preferring to believe that all supply and demand changes are private sector failures, and government intervention is capable of managing the market. This is plainly wrong. The private sector had already responded to the changed trading environment by slashing prices, since that is what was required to retain equilibrium. Those manufacturers unable to make money at the new price level in a free market have a choice of making losses, rationalising their businesses, or closing.
None of these are political decisions.
Consumers who benefit from an efficient market, and who actually want to buy cars, are the losers from scrappage subsidies, and this was confirmed by the disappearance of the best discounts shortly after the scheme was introduced. Thank you to the state for taking our money to make our new cars more expensive.

Secondly, we need to question the environmental benefits. It is true that old cars are less fuel-efficient than new ones, but to the extent that these subsidies lead to new cars being manufactured, you need to account for the environmental cost of production, which probably eliminates all the environmental benefits of the scheme. There is also the effect on scrap metal prices. In the UK, No 1 old steel scrap has fallen from £239 per tonne in June 2008 to £64 per tonne in June this year. This is very painful for the recycling industry, and at the margins, government car scrappage schemes are probably closing recycling businesses by driving scrap prices to artificially low prices. Is this an environmental benefit?

Thirdly, there is the effect which is hardest to appreciate, because it is spread so thinly. Government funds these schemes through general taxation. If it costs £300m as estimated in the 2009 budget, this is a cost of about £12.50 foregone by each household, money which would have been spent or saved through individual choice. It is this spending and saving that helps makes an economy competitive. Perhaps £12.50 is not a lot in the context of a household’s annual budget, but this is just one of many government schemes that diverts money from people’s pockets, money that is no longer making markets work efficiently for the benefit of us all.

So we must conclude that a relatively uncontroversial scheme with headline objectives that are hard to disagree with, when assessed after taking into account indirect and longer-term consequences, scores nought out of three. At least, gentle reader, I haven’t assaulted you with a diatribe on financial regulation, where the laws of unintended consequences operate more obviously.

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Alasdair started his career as a stockbroker in 1970 on the London Stock Exchange. In those days, trainees learned everything: from making the tea, to corporate finance, to evaluating and dealing in equities and bonds. They learned rapidly through experience about things as diverse as mining shares and general economics. It was excellent training, and within nine years Alasdair had risen to become senior partner of his firm. Subsequently, Alasdair held positions at director level in investment management, and worked as a mutual fund manager. He also worked at a bank in Guernsey as an executive director. For most of his 40 years in the finance industry, Alasdair has been de-mystifying macro-economic events for his investing clients. The accumulation of this experience has convinced him that unsound monetary policies are the most destructive weapon governments use against the common man. Accordingly, his mission is to educate and inform the public in layman’s terms what governments do with money and how to protect themselves from the consequences.

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