Did Cash for Clunkers “Revitalize” the Auto Industry?

During a recent conversation with a friend, he told me that the Cash for Clunkers program had “done wonders” for the auto industry. Indeed, he hardly is alone.

Automotive News recently editorialized that the program “worked,” and now it is time to “build on its success.” The editorial declared:

The August U.S. light-vehicle sales tally reported last week proves that the government’s cash-for-clunkers program was a huge success. Now it’s up to automakers and their dealers to be clever marketers and salespeople to maintain and build on the clunkers momentum.

From the beginning, there were doubters who, for political or other reasons, said the clunkers program was little more than a federal handout to the Detroit 3. But the rising tide of enthusiasm among U.S. consumers for purchasing new cars lifted many automakers, not just those with a fleet full of fuel-sippers.

The writer adds:

Better yet, dealers say cash for clunkers sparked a positive shift in consumer attitudes that will lift new-car sales in the months ahead, especially if economists are right about positive indicators.

This editorial was written two weeks ago, The industry has come back to earth with a thud since then. The Boston Globe reports that things are rather quiet in the aftermath:

...once the federal money dried up, so did the sales rally. Now, customers at dealerships like Silko Honda in Raynham are few and far between, and inventory is once again accumulating.

Manager Adam Silverleib said business was “pretty intense” as a result of the federal stimulus program, with the dealership hustling to accommodate customers and handle the piles of paperwork required for them to receive reimbursement on vouchers. “Now we’re kind of back to where we were in the spring,’’ he said.

And what was it like in the spring? It was called a recession, with recession-like sales figures to boot. In other words, one can liken the Cash for Clunkers program to throwing lighter fluid on damp wood. Flames will rise up for a few minutes, but unless the wood catches fire, the lighter fluid was next-to-worthless.

Contrary to what Automotive News breathlessly declared, the Cash program pretty much was what anyone with common sense and decent economic training could have predicted. It spurred sales for a while, but after the money dried up, so did the new car sales.

I contend, however, that where Automotive News saw “momentum” for the auto industry, in reality this program has brought long-term economic damage. To understand why the program was, on net, economically harmful, one first must understand Frederic Bastiat’s “broken window fallacy.”

Since most, if not all, readers are familiar with this fallacy, I don’t need to repeat it. However, the most important part is that while the townspeople believed the broken window brought prosperity, it actually reduced their wealth because they were forced to use resources to recreate a window which already had existed, thus depriving the community of the use of those resources elsewhere.

With Cash for Clunkers people turned in vehicles on which they were making small if any payments.. In normal situations, if they had wanted another vehicle, many would have traded in what they had for another used car or truck. Instead, even though they were given a fairly large down payment, many purchased cars that substantially raised their personal debt.

To make matters worse, the government ordered the dealers to destroy the engines of the so-called clunkers, many of which were not clunkers at all. Thus the government managed to destroy a huge amount of wealth, all in the name of creating wealth. Furthermore, if any automakers or dealers used the Clunker program as a reason to engage in new capital expansion, they quickly will find that those “investments” really are malinvestments, which means they will be worse off in the long run because they diverted resources to lines that won’t be profitable.

Like so many government programs, Cash for Clunkers, while creating some short-run benefits for a few people, will have negative effects in the long run. I suspect that even the editors of Automotive News will realize sooner or later that it was a lemon.