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How Would We Figure Out Whether Cash-for-Clunkers Makes Sense?

8/5/09 10:29 PM

Grasping Reality with Both Hands The Semi-Daily Journal of Economist Brad DeLong: A Fair, Balanced, Reality-Based, and More than Two-Handed Look at the World J. Bradford DeLong, Department of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 708 0467; delong@econ.berkeley.edu.

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How Would We Figure Out Whether Cash-for-Clunkers Makes Sense? Andrew Samwick makes the intelligent criticism of cash-for-clunkers: And for an Encore, Let's Condemn Office Buildings and Rebuild Them Nearby | Capital Gains and Games: By my reading, Stan did not disagree with anything I posted about Cash for Clunkers. None of the three criticisms of the C4C program that he addressed were leveled by me. My criticism is that it is a waste of assets, and that a waste of assets necessarily makes us poorer... http://delong.typepad.com/sdj/2009/08/how-would-we-figure-out-whether-cash-for-clunkers-makes-sense.html

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How Would We Figure Out Whether Cash-for-Clunkers Makes Sense?

8/5/09 10:29 PM

necessarily makes us poorer... A clunker burns a lot of fuel that has a social cost a lot bigger than its private cost. The destruction and replacement of a clunker by a more fuel-efficient car boosts spending (somewhat) and do reduces the Okun gap (somewhat). Clunkers are made up of (a) cars that would have been junked anyway and (b) cars that had positive value but value less than $5,000. Suppose we set $2,000 as the value of the assets wasted by destroying clunker, and $2 a gallon as the social waste in carbon-fueled gasoline, and 12 mpg as the average differential mileage between a clunker and its replacement. Then destroying a clunker is worth doing on (a) alone if... ... the clunker would otherwise have been driven more than 12,000 miles before being replaced. And, of course, there is factor (b) to consider as well. It doesn't look like an overwhelming benefit-cost ratio--there are other things we could be doing that are much lower hanging fruit. But I would not feel confident arguing for Andrew's position that "it is a waste of assets, and that a waste of assets necessarily makes us poorer..." without doing a bunch more work. Anybody seen anything serious on this? **UPDATE: Touche. If the clunker gets 12 mpg, then it is not 12K but 24K that the clunker must have been driven before replacement for the program to make sense based on (a) alone... rated 4.67 by 3 people [? ] You might like:

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Posted by: Pancho | August 05, 2009 at 07:38 PM "Clunkers are made up of (a) cars that would have been junked anyway and (b) cars that had positive value but value less than $5,000. Suppose we set $2,000 as the value of the assets wasted by destroying clunker, and $2 a gallon as the social waste in carbonfueled gasoline, and 12 mpg as the average differential mileage between a clunker and its replacement. Then destroying a clunker is worth doing on (a) alone if... http://delong.typepad.com/sdj/2009/08/how-would-we-figure-out-whether-cash-for-clunkers-makes-sense.html

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How Would We Figure Out Whether Cash-for-Clunkers Makes Sense?

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worth doing on (a) alone if... ... the clunker would otherwise have been driven more than 12,000 miles before being replaced." 1) Your math is blatantly wrong. The difference in gasoline used between a clunker driving 12000 miles and a non-clunker driving 12000 miles is NOT 12000 miles / (difference in mpg). If we represent the mpg of the clunker by mpg_c and the mpg of the new car by mpg_n then the difference in gasoline burned is 12000 * (1/mpg_c - 1/mpg_n). According to the following news story, http://www.latimes.com/business/la-fi-clunkersbox5-2009aug05,0,422056.story the average mpg of clunkers so far has been 15.8 while the average mpg of new cars purchased has been 25.4 (note that using the mean value is a poor measure; we should be using the harmonic mean, but what the hell: go with what you're given) the difference in gasoline burned over 12000 miles for these "average" figures is 258.7 gallons, or 517.4$ net externality saved according to your figure 2) An externality of 2$ per gallon seems ridiculously high to me. This would imply a carbon externality of 850$ per ton (1 gallon of gasoline contains ~2.4kg of carbon), which is significantly above the reasonable externality estimates I've seen (which range from 1015$ per ton of carbon up to 300$ per ton of carbon Posted by: MattM | August 05, 2009 at 07:47 PM Using the high-end estimate of externality I gave and the "average" figures for clunkers and new cars, then the clunker being replaced would have to be driven for 130 000 miles in order to make destroying 2000$ worth of car be sensible. Not to mention the fact that the 2000$ worth of car is destroyed NOW, while the emissions happen over time, so they should be discounted according to your favourite discount rate. At 4% discounting and 15000 miles a year the figure probably goes to 160k miles or so. Posted by: MattM | August 05, 2009 at 07:53 PM In addition to these major concerns there are the following "minor" concerns: 1) This is a static analysis. People with better mpg will drive more 2) The carbon externality associated with actually building a new car is likely not 0 3) The selfish argument: the externality associated with carbon emissions is distributed globally, while the cost of junking American cars is paid nationally 4) The "there's a better way" argument: the government picking a number out of a hat and destroying that many old cars is certainly not going to be the most efficient way to reduce carbon emissions by a given amount; allowing the market to make that determination via a uniform price of carbon (either due to a carbon tax OR cap&trade) will always result in cheaper cuts Posted by: MattM | August 05, 2009 at 08:14 PM The main objection I have to the expansion for CfC is pretty simple: we're leaving a lot of benefits on the table. If the program was so ridiculously popular that it went through $1B in less than a week, given that there are limited resources, the thing to do when expanding it (with an extra $2B) is to tighten the criteria needed to qualify so that the bang-for-buck is much higher. What kind of criteria? Lower the MPG requirement for the clunker (from 20 to 18 or 15), or increase the age requirement. Bump up the MPG requirement for the purchase (to 25 or 30 minimum). Require that it have been registered (and therefore drivable) for the last six months. Et cetera. If that means that the next $2B take two months to polish off instead of two weeks, who cares? The average improvement in MPG per car will be vastly higher. Posted by: Ivan | August 05, 2009 at 08:28 PM Interesting...in criticizing his math I made a typo in my own: 1) 12000 miles gives 306.8 gallons difference using the average figures = 713.6$ externality if externality = 2$ per gallon 2) This error propagated through, so the high-end externality gives 95k miles driven on the clunker as the break-even, or ~110k at a discount rate of 4% Posted by: MattM | August 05, 2009 at 08:41 PM This program didn't create new demand. It shifted some pent-up demand forward a quarter or two, at a very high cost per vehicle. (Not only the subsidy but the destroyed capital stock too.) Stimulus should be public investment that otherwise would not have http://delong.typepad.com/sdj/2009/08/how-would-we-figure-out-whether-cash-for-clunkers-makes-sense.html

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How Would We Figure Out Whether Cash-for-Clunkers Makes Sense?

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(Not only the subsidy but the destroyed capital stock too.) Stimulus should be public investment that otherwise would not have happened, not some very expensive intertemporal shuffling. Drivers who trade in clunkers now are drivers who don't need a replacement vehicle in a year or two when the plug-in electrics come out. Posted by: Mr. Me | August 05, 2009 at 08:48 PM Okay, one last time: 287.1 gallons difference = 574.2 $ if externality is 2$ per gallon For actual externality estimate of 300$ per ton of carbon the externality over 12000 miles is more like 202.6$, so you need 118k miles to break even Sorry for all the posts. I'm pretty confident that it's right this time...I'm good at pushing symbols, but not pushing numbers on a calculator apparently... Posted by: MattM | August 05, 2009 at 08:57 PM There are two driving elasticities that are affected by a change in mpg. Better mpg leads to (1) driving more miles and (2) driving less fuel efficiently, such as more quick accelerations and quick stopping. A 2004 multinational UK study, which includes some US states, discusses the actual elasticities. See, "Elasticities of Road Traffic and Fuel Consumption" at http://www2.cege.ucl.ac.uk/cts/tsu/papers/transprev243.pdf. Additionally, used car sales are much more profitable for dealerships than new car sales. See "The Vital Importance of Used Cars" at http://www.naaamap.com/NAAA/pdfs/The_Importance_of_UsedCars.pdf. I do not remember any mention of C4C program compensating dealers for the lost profit on the used car sale of a trade-in. The dealers will lose the profit on the sale of a used car. Used car prices may rise, which will decrease future used car sales and dealer profitability. The new car sales are good for the manufacturers, Ford, etc., but may be bad for the dealers. When France tried a similar program over a decade ago, the incentive accelerated many future car sales into the incentive period and there was a severe drop in car sales the year following the incentive program. The C4C program will achieve a much lower improvement in total fuel use and environmental benefit than promoted, will decrease dealer profits and may decrease future new and used car sales. Posted by: Milton Recht | August 05, 2009 at 09:06 PM Brad, You have made the fatal error of accepting your opponent's premise. The good news for you is that your opponent's premise is so weak that it wilts even under the lackluster attack you mounted. You would have been better served to attack the premise, which seems to be that every decision made needs to be considered on its own, strictly in terms of expected value, without regard to the larger context in which it is made; that one never consider the strategic value of a decision. But value is something that has multiple dimensions, not just the one to which Andrew clings. Lord Keynes made a singularly shrewd observation about market dynamics back in the early 1930s, and it changed a problem that happened once every 10 years into a problem that took another 80 years to manifest itself (and that's only because neoclassical econmics buried what Keynes actually taught). Keynes wins. Samwick (who is he, again?) loses. Posted by: Tao Jones | August 05, 2009 at 09:18 PM Yes, Brad, your math is very wrong here. MattM is correct about that. It seems unlikely that this would pay off in terms of energy savings even with social costs factored in. But here is my other concern about the program: suppose I forget about any environmental and energy issues and assume that the only goal is to stimulate the car market. Isn't the fact that this program sold out in a few days a sign that the government paid too much per car? Given a limited pool of money, say $1 or $2 billion, is there a better mechanism to determine a price that maximizes the number of cars bought? Some sort of auction process? I guess someone must have studied this case already. Posted by: TS | August 05, 2009 at 09:45 PM http://delong.typepad.com/sdj/2009/08/how-would-we-figure-out-whether-cash-for-clunkers-makes-sense.html

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How Would We Figure Out Whether Cash-for-Clunkers Makes Sense?

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I originally thought the program was a very bad deal, for the sorts of arguments people have posted above. But, per amount of government spending the sorts of delta for GDP I've seen bandied about are quite high, i.e. the multiplier seems to be pretty impressive. I think the reason, is that we are overcoming the well known economic effects of excessive thrift by tapping into private borrowing by private citizens. So as stimulus it is effect policy. As far as energy is concerned it is not very cost effective. A few comments on the externalities of consuming gasoline: (1) Global warning: close to zero. Not because CO2 isn't a climate change culprit, or because gasoline doesn't produce CO2, both of these statements are patently false. Rather, we are just freeing up a unit of oil for someone else to consume. We are probably (via a small decrease in the market price of oil) leaving a tiny bit more oil in the ground, and perhaps leaving a bit more in the ground a little bit longer. But I would argue that only a tiny fraction of that gallon will actually be left in the ground at the end of the oil era. Given the long lifetime of CO2 in the atmospere, longterm leaving the barbon in the ground is the only thing that matters. (2) Since we are a big time oil importing nation, and our trade deficit is an important problem, the externalities as far as the US is concerned are primarily (a) We will need to import somewhat less oil, and (b) The price paid per unit of imported oil will be lower. (3) There are a couple of minor externalities. Local pollution is one. I would claim vehicular safety is another, i.e. a new car is safer both for its occupants, and for the occupants of other cars it shares the road with. Posted by: bigTom | August 05, 2009 at 09:53 PM

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How Would We Figure Out Whether Cash-for-Clunkers Makes Sense