The Unseen Economic Harm Wrought by Clunkers

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Listening to politicians, columnists, reporters, Wall Street economists, and car dealers crowing about what a success (if an unintended one) the cash for clunkers program has become, you'd think that Washington had created a modern version of the miracle of the loaves and the fishes. The program has not only boosted car sales, but its "multiplier effect," as a newspaper headline suggests, will somehow take the $1 billion in tax money we are spending to subsidize the purchase of new cars and turn it into how much in additional economy activity?...$2 billion?...$5 billion?...$10 billion?

And you thought the age of miracles had passed.

The rush to renew and extend the program, which offers government rebates of $3,500 to $4,500 for consumers to purchase new, more energy-efficient cars, is based on the misleading notion that Washington can spend our tax money without any consequences. And so Sen. Charles Schumer can declare that the cash for clunkers program is "working in every way" because he believes that that $1 billion that Congress allocated to the program was somehow free money that was doing nothing when it was in our pockets. For someone like Schumer, who has spent his entire adult life working for government, that's how economies work. The rest of us should know better, however.

Schumer can make such declarations because too often the rest of us-and that includes economists, politicians and journalists--don't consider the unseen consequences of programs like cash for clunkers. As the renowned 19th century French economist Frédéric Bastiat noted in his classic work, "What Is Seen and What Is Not Seen," the impact of a spending program like cash for clunkers goes beyond the visible and the obvious. First we offer people a big subsidy to buy cars and they buy more, so car sales go up. Pretty simple. But as Bastiat noted, "Other effects emerge only subsequently," and often "the later consequences are disastrous." That sounds a lot like Washington policymaking.

The cash for clunkers program is rich material for a discussion of unintended consequences. The program proved so popular that it ran out of money in just a few days, when it was intended to last well into the fall. In other words, government architects of the program overpriced the rebate-which is not surprising because Washington policy makers know little about consumers--and could have gotten people into showrooms for less. So whatever "multiplier effect" (that is, additional spending) this government subsidy prompted was diminished by the fact that we bought the additional spending at a high price.

A certain amount of further waste was inherent in the program because government has no way of knowing which consumers would have otherwise bought a car without the subsidy. So we paid some people to do what they would have done anyway. In addition, we pulled forward some purchases by prompting people who qualified for the rebates to buy a car now that they might have purchased a year from now. Many politicians and some economists (most especially on Wall Street, where economists often act as cheerleaders) seem to think this is fine, because it produces the spending now, when we need it. But there are consequences to government subsidies that pull buying forward, which become addictive to politicians who want the increased spending to appear at the most auspicious times for them, like when their poll numbers are down. In Europe, for instance, car makers fear the end of a similar 2008 rebate program because they've pulled so much buying forward they anticipate a slump once rebates end.

One of the best examples of the dangers of what I am talking about is the housing market. Back in the early 1990s, with the economy still in the doldrums and the housing market drifting, President Clinton's housing secretary, Henry Cisneros, began pushing for policies to ease credit in order to expand home ownership. Later, the Bush administration, seeing the political boon that resulted from a vibrant home market, promoted its own version of the "ownership society." As a result, by 2007 homeownership rates had soared from 65 percent of all households in the mid-1990s to nearly 70 percent of households. But the gains were entirely because we pulled homeownership forward: Home ownership rates for adults 25 and younger increased to 24 percent from 19 percent, and to 41 percent from 37 percent for those 26 to 30 years old. Meanwhile, they barely changed at all for those 44 and over.

This is also one reason why our current recession is so deep and lasting so long. In previous housing downturns these young adults would have been precisely the first-time buyers who would have leaped in at the initial slump in prices and starting buying, thereby buoying the economy. But by pulling their buying forward we made these young adults part of the problem in the housing market, not part of the solution. This is why it's dangerous to have government deciding when the economy most needs a boost, and doing its best to give it to us with our own tax dollars.

But perhaps the hardest unintended consequence to explain is how a program like cash for clunkers diverts money away from other, potentially more productive uses, which we can't see. When the government gives subsidies for cars and sales go up, that's easy to see. But what we don't see is how people buying cars might have otherwise spent their money had they not been induced by our tax dollars to funnel their earnings into a new auto. What other industry will suffer when the person who used cash for clunkers has to make the monthly $300 payment that's financing his new car? What financial institution will have less to lend to others, like local businesses, because someone withdrew from savings to buy the car?

As Bastiat himself wrote, "To save is to spend," because our thrift provides capital that gets lent to others and comes back to us in the form of increased savings. That's money that we can use one day to consume more-like buying a car that we can afford without a government subsidy.

Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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