The (confused) economics of cash for clunkers

According to Justin Fox in his August 4, 2009 article "The (confused) economics of cash for clunkers" in TIME magazine:

It all began a year ago with a suggestion from a prominent economist. Wrote Princeton University's Alan Blinder in the July 27, 2008 New York Times:

Economists and members of Congress are now on the prowl for new ways to stimulate spending in our dreary economy. Here's my humble suggestion: “Cash for Clunkers,” the best stimulus idea you've never heard of.

Now, of course, cash for clunkers is a spectacularly successful—and controversial—reality. The rebate program that rewards people for turning in older gas hogs and replacing them with more efficient new cars has run through its $1 billion in funding in a matter of weeks. The House voted 316-109 Friday to expend another $2 billion on the program. In the Senate it's looking to be more of a battle. The most interesting debate about Cash for Clunkers, though, may be the one among economists.

Blinder, a respected former Federal Reserve vice chairman and member of President Clinton's Council of Economic Advisers, pitched cash for clunkers as a program to stimulate the economy in a way that was both environmentally friendly (because it got polluting, gas-guzzling cars off the road) and helped the poor (because low-income Americans tend to be stuck with the least-efficient cars). The idea of cash for clunkers wasn't new—such programs have existed at the state level ever since the Clean Air Act amendments of 1990 encouraged states to pursue market-based approaches to improve air quality. What was new about Blinder's pitch was its combining of environmental objectives with Keynesian economic ones.

Now that cash for clunkers is reality, can we say that it has achieved those objectives? Well, as so often with economic matters, the answer seems to be, it depends.

* Stimulus. By all accounts the program has driven a rush to car dealers. Auto sales in July were at their highest pace in 11 months. In an e-mail to clients Monday, Credit Suisse economist Neal Soss revised his economic growth forecast for the third quarter from 1.3% to 2.0%, and for the fourth quarter from 2.0% to 2.5%—all on the basis of cash for clunkers' success. Of course, to believe this you have to believe the Keynesian story that deficit spending by the government actually can stimulate the economy. There's a rearguard of conservative economists who think that such spending has little impact, but their arguments haven't been very convincing lately (Justin Lahart has a nice summing-up of the debate in the WSJ today). There are other economic concerns about cash for clunkers, though. It distorts incentives, which over time can lead to all sorts of weird side effects (economist Steven Levitt suggested, back when Blinder first proposed the idea, that "one of the most visible responses to this program" might be "a new market for mechanics fixing up cars that don't run at all just enough so that they can be driven to the government's lot to collect the cash,"1 and commenters to this blog offered a several caveats of their own when I floated the idea last fall). Also some economists caution that the boost in economic growth brought by junking older cars and replacing them with new ones may be mostly chimerical—since the lost value of the junked old cars isn't reflected in economic statistics. Still, seen strictly as a means of getting money temporarily flowing into a particularly stricken part of the economy, cash for clunkers does seem to be working spectacularly well. For whatever that's worth.

* Environment. Cash for clunkers programs arose in the U.S. and Europe in the 1990s as environmental measures intended to get the most polluting cars off the road. The two main assessments I've been able to find of their effectiveness, a 1992 study (pdf) by the late and lamented Office of Technology Assessment (OTA) of an early cash-for-clunkers pilot program in Southern California and a 1999 report by the European Conference of Ministers of Transport (ECMT), both came down on the positive side, but only barely. The design of the program was deemed crucial. The initial California program was aimed only at pre-1971 vehicles, which made it very effective because those cars predated modern emissions standards and concerns about fuel economy—they were truly clunkers. Schemes to scrap cars that were less old and decrepit, the OTA said, would deliver less bang for the buck. The ECMT, meanwhile, concluded that "cash-for-scrappage" programs (where you just turn in your old car and get a check) could be cost effective ways of reducing emissions but that "cash-for-replacement" programs (the payment for scrappage is contingent upon buying a new car) generally were not—in part because stimulating the production of new cars meant increasing emissions from manufacturing. The current U.S. cash for clunkers program is (a) not targeted only at older vehicles (vehicles more than 25 years old aren't even eligible) and is (b) a cash-for-replacement scheme. So it probably can't stand on its own as a positive environmental step, even though the gas mileage of the new vehicles purchased so far has been encouragingly high. There is, however, an intriguing international complication: In a new paper, economists Lucas Davis and Matthew Kahn describe how the North American Free Trade agreement has enabled big-time exports of used cars from the U.S. to Mexico. This export flow has improved the gas mileage and emission standards of the Mexican automotive fleet—but because it has enabled Mexicans to keep driving cars that in the U.S. would have been scrapped, Davis and Kahn estimate that it has increased overall emissions. A cash for clunkers program would slow the export flow to Mexico, thus reducing at least that particular source of auto emissions (while also depriving some Mexicans of cars, of course).

* Income distribution. A cash-for-scrappage program—which is what Blinder was suggesting a year ago—could potentially be a boon to poor people who could replace their clunkers with less-polluting and more fuel-efficient but still cheap used cars. In the interest of boosting the beleaguered auto industry, the current cash for clunkers program requires that those who turn in old cars buy brand-new ones. No help for the poor there.

In short, the economic verdict is ... complicated. But what did you expect?

Update: Now I've gotten Alan Blinder's (brief) take on how things are panning out:

"I always thought that cash for clunkers would be an effective stimulus, but it seems to have exceeded expectations. It would be a shame to cut it off here. The original bill was way under-budgeted.

That said, I wasn't happy with the design details, which pay too little attention to environmental concerns."

1. bryanfromhouston points out in the comments that Levitt's concern doesn't apply to the cash for clunkers bill that Congress actually passed, which requires those who trade their clunkers in to have had them insured for at least a year.