Scrap ‘Cash for Clunkers’ scheme, not older cars

Published in The Australian (Sydney), 30 July 2010

PRIME Minister Julia Gillard’s “Cash for Clunkers” scheme may have borrowed its nickname from Barack Obama’s car-scrapping program. But the actual idea is “made in Germany”.

Germany is not only the country in which cars were invented. It’s also the country that invented the policy to destroy them while they are still fully operational. And it is also the best example to study why “cash for clunkers” schemes are a piece of economic lunacy.

During the economic crisis in early 2009, the German government started giving cash benefits to owners of old cars if they scrapped and replaced them. It was, of course, entirely accidental that the policy coincided with an election campaign and that the funds allocated to the scheme were meant to last until polling day.

A total of €5 billion ($7.25bn) were made available to scrap two million cars, paying €2500 for each one that made its way to the car baler. Officially labelled the “environment premium”, the policy was intended to help the environment by removing gas-guzzlers from the streets. It was also meant to support struggling German car manufacturers. On both counts, it failed miserably. To make matters worse, it also had a number of unintended side effects.

For a policy that presented itself as ecologically motivated, it was astonishing that fuel efficiency was not a criterion for the grant of the premium. The standards were set so low that every sports car or SUV could qualify for a subsidy. Scrap your 15-year-old VW Polo to buy a Lamborghini Murcielago? No problem.

Strangely enough, just getting rid of your car was not an option to benefit from the government’s generosity. If you decided to stop driving altogether to only take public transport or ride your bike instead, the policy did not deem this worthy of encouragement.

Even if the beneficiaries of the cash premium opted for new, fuel-efficient cars to replace their old gas-guzzlers, the environmental effects were questionable. A car’s environmental impact does not only depend on how much petrol it consumes. It is also the production of the car itself, which accounts for a big chunk of the energy consumption over its life cycle. Scrapping a car before the end of its useful life therefore necessitates an additional consumption of resources and energy. The marginal reduction in petrol consumption rarely justifies this.

With the environmental benefits largely imaginary, did the so-called “environment premium” at least reach its industrial policy ambitions? Again, the answer is negative. While it is true that German car dealerships received a boost from the program, it is doubtful that the government actually supported its national car industry. In fact, it mainly benefited foreign competitors.

The strongest segment of Germany’s car manufacturers is the middle-class and premium end of the market. But the consumers most likely to be susceptible to the inducement of a premium are those at the bottom of the market. Put simply, if you consider buying an expensive BMW or Mercedes, an extra €2500 does not matter that much. Apart from that, your current car would be worth more than the government’s scrapping premium anyway. It was for this reason that the real beneficiaries of the “cash for clunkers’ scheme were the manufacturers of small and inexpensive cars from countries such as Italy, Japan or Korea. The market share of German car manufacturers actually declined thanks to the government’s program, hardly the result that politicians in Berlin had in mind.

To make matters worse still, the government program also effectively destroyed the second-hand car market. For people on small budgets such as students, it was virtually impossible to buy any cars under the price of €2500 as they had all been destroyed.

Apart from that, the international export of used cars to Eastern Europe and Africa, worth more than €6bn before the scheme, also dried up for the same reason.

As if all of this was not enough, car repair businesses reported serious difficulties. With many older cars being taken off the roads, there were fewer cars left in need of servicing. But garages were not the only industry to complain. Furniture stores and whitegoods dealers pointed out that with consumer spending being redirected towards the purchase of new vehicles, less money was spent on other goods. This was hardly surprising as even efficient Germans can spend every euro only once. To short-sighted politicians, this must have been an unexpected side effect just like the decline in scrap metal values after the sudden destruction of two million cars.

For the biggest destructive effect, though, no advanced economics knowledge would have been necessary. If a government sets off to systematically destroy assets, this can hardly be deemed a value-creating exercise.

As a final irony in the whole “cash for clunkers” saga, only a few months after the end of this €5bn folly, the German government discovered that its public finances were in such disarray that tough budget consolidation measures were needed to reduce the debt. Needless to say, these measures now had to be larger thanks to the previous spending binge.

Australia should study the German “environment premium” example closely in the debate over the Prime Minister’s “cash for clunkers” proposal. It was one of the most bizarre and wasteful programs ever to be implemented by any government.

Instead of scrapping hundreds of thousands of perfectly functional cars for imaginary benefits, the Prime Minister would be better advised to scrap her lunatic proposal.

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