There has been much ink spilled over the environmental and economic costs and benefits of the federal government’s “Cash for Clunkers” program (officially known as the Car Allowance Rebate System)- whether the higher gas mileages outweigh the benefits of new raw material use, whether the foreign automobile sales really helped the American economy or whether the money spent there would have been spent elsewhere anyway.
But a certain economic aspect of the program I have not heard frequently addressed frequently is the resulting deadweight loss from the economy in the long term because of the inefficiency resulting from taking an entire segment out of the used car market.
For simplification, I will disregard the requirements and break vehicles into three segments based on economic value in a hypothetical regular market:
Group A. High Value: > $4,500
Group B. Medium Value: $1,000 to $4,500
Group C. Low Value: < $1,000
Here it is important to pose a new vehicle to purchase in our hypothetical example, and we select the cheapest to find out what the minimum cost to the consumer is in this program. The Hyundai Accent GS Base is the cheapest new car on the current market, running around $10,000. In the highest rebate Cash for Clunkers category, the consumer can receive a $4,500 credit. This leaves the consumer paying, at a minimum $5,500 to participate in the Cash for Clunkers program.
Minimum Vehicle Cost ($10000) – Maximum Rebate Allowance ($4500) = Minimum Consumer Cost ($5500)
Group A, the highest value used cars, are not worth trading into Cash for Clunkers because they are worth more on the market than the value of the rebate.
Group B, the medium value vehicles, are the most useful for Cash for Clunkers, because the economic return to the consumer is greater than the value of the car. Additionally, individuals owning cars valued at $1,000 to $4,500 are far more likely to be able to afford the minimum consumer cost of $5,500 for a new vehicle, unlike:
Group C, the low value vehicles. Like Group B, the economic return is greater than the value of the car, greater even than those consumers in Group B. However, these consumers are much less likely to afford the minimum $5,500 necessary to take part in the program.
The clincher comes when one considers what Group C will do 1-5 years in the future as their low values cars necessarily need replacement. Normally, consumers in Group C would move to cars in Group B that have reduced in value enough to become affordable to them. However, many of the Group B cars have been taken out of the market due to the program. The result is a future bottleneck as demand outstrips supply of Group B cars as Group C begins to need them.
Group B vehicle prices will increase. However, because having a vehicle in the US is rather inelastic (ie, necessary, so the demand will not change much) consumers in Group C must either spend a higher percentage of money on these vehicles (at the cost of something else) or suffer the potential economic, employment and social consequences of not having a vehicle, which are rather great in the United States. Many on the edge of affordability will not have a choice and will be forced to take the latter.
This scenario, which government and consumers have gladly bought into in the Cash for Clunkers program, is called ‘deadweight loss’ a term describing an economic inefficiency when goods and resources are not allocated efficiently. When we talk about efficient resource allocation, we are also talking about environmentalism. Although we must use natural resources to live, environmentally conscious living uses the least resources for the greatest gain, which is also economic efficiency.
When doubts about the ostensible environmental and domestic financial short term gains from the program are put into the equation, we will only be able to look back at the Clash for Clunkers program with regret.
