Cash for clunkers, broken windows, and free lunches

It is quite fashionable at the moment to refer to the "cash for clunkers" program as an example of the "broken window fallacy".  See here, for example (Seeking Alpha).  Well, at least "cash for clunkers" is not mandatory.  A hurricane or a tsunami doesn't give you a choice about whether to participate in the destruction.  That is certainly an important difference.  But as the article from Seeking Alpha makes clear, the real similarity that matters is that it results in a net loss of value.  Let's explore this idea.

My last post on the subject made the observation that it just shifts the spending intertemporally, and therefore the auto industry will likely see a decrease in demand when it's all over.

Commenter "Lord" remarks that this is ok, even desirable.  It means a boost in production when you need it and a decline later that will reduce the threat of inflation.

First of all, it is unclear what effect this will have on production.  Sales have increased, and it is drawing down inventories.  But the automakers know that this might not be sustainable.  This article from Edmunds Auto Observer makes the point:

"If we can sustain this momentum in the industry, it will translate into having a very good ability - for the first time in a long time - to increase production," said Michael DiGiovanni, GM's executive director of global market analysis. "And that will help stem the rising tide of unemployment, and will feed on itself to revive the economy. Recoveries are usually fed by the auto sector."
 
But displaying appropriate caution, neither DiGiovanni nor any other auto company executives pledged immediately to boost production in the wake of CARS mania. LaNeve said that GM is "looking for ways to add production" during the third and fourth quarters, but he didn't make specific promises.

Read the rest of the article.  You will see that industry experts really don't know what will happen going forward after this rebate comes to an end.  Good for dealers?  Yes.  They get rid of inventory they've been unable to move.  Enough to save the Big-Three?  I don't see it.

If the argument is that this is a sort of Keynesian "pump-priming" that will get us out of a bad equilibrium (coordination failure, for all you grad students out there), then I admit to being skeptical.  I guess if 3rd quarter GDP is positive we can pretend it was CARS that did it (even though a lot of folks have been predicting that for a while anyway).

Commenter "Jake" concurs with "Lord" that it will end the recession faster and adds that the net effect of the program will be positive.  "Jake" doesn't go into detail about how he arrives at that conclusion.  So I'm left to try to fill in the blanks.  Luckily, people have made similar arguments about natural disasters (and committed the "broken windows fallacy").

One positive effect usually mentioned is the increased spending.  But as we've stated (and "Lord" would seem to agree), this is just intertemporal substitution.  If you don't buy the pump-priming argument, then this isn't a long-run benefit.  (Is a billion dollars really enough to prime the pump?  Seems like a drop in the bucket.)

The other positive effect is that we have exchanged--in aggregate--inefficient cars for more efficient ones.  We'll save energy and the environment.

Ok.  But as Mark Perry points out, with more fuel efficient cars people might drive more because it costs less.  I would stop short of saying that it would actually harm the environment without more information.  But it is perfectly reasonable economic logic to say that the environmental benefits will be less than advertised... especially in light of this.

But I'll be generous and say that there is some environmental benefit.

Now, those cars would have been taken off the road at some point anyway, right?  So the net present value of the environmental benefit would only be the reduced emissions that would have gone out from now until the time of that car's eventual disposal.

So again, it is less benefit than is being advertised.  But if the environment benefits at all, it's all good right?

Not necessarily.  There's no such thing as a free lunch.

It still cost the government something.  That's money that won't be spent on something else.  Granted, a lot of the praise for CARS is that it is a better way to spend money than bailing out banks and so on.  But a dollar of spending today equals a dollar of future taxes in present value terms.  No free lunches.  Are the environmental benefits worth the money being spent?  If not, then we're just breaking windows.

I don't know the answer to that question with certainty, nor do I think that Congress had enough information to answer that question.  The truth is that this program is easy to administer and easy to explain to people.  It's politically expedient, and that carries a lot more weight in Washington than its economic merits (or lack thereof).

As policies go, it's probably better than some ways to spend money and worse than others.  But to those who think it is undeniably a net benefit to the economy, then I would ask, why stop at cars?  Why not distort the prices of some other things that could be replaced with more energy efficient versions and let the government pick up part of the tab?  Why not tear down rodent and asbestos infested old inner-city school buildings and replace them with safer high-tech environmentally sound buildings?  Sure it would cost more upfront, but the energy savings and the environmental impact would be enormous.  And think of the jobs!

It's not about the environment or the jobs, is it?  It's about politics.