Rob Saker's Blog

The government released facts on it’s “Cash for Clunkers” program. This program was positioned as a way to assist an industry in trouble and reduce the carbon impact of cars by improving fuel economy.

While it’s too early to determine the true impact of the program, the initial facts do illustrate some interesting findings.

The Facts

Here are the facts that were released by the government:

• Participation: 690,114 “clunker” claims.
• Cost of Cash for Clunkers Program: $2.88 billion
• Average MPG for Trade-ins: 15.8 mpg
• Average MPG for New Cars: 24.9 mpg

The automakers that most benefited from the program were Toyota, Honda and Nissan, with 41 percent of the new automobile sales. The “Big 3″, GM, Ford and Chrysler, accounted for 39 percent. Toyota alone had 19.4 percent of the overall sales.

Initial indicators suggest this will contribute 0.3 to 0.4 percent for Q3 economic growth.

If we assume the average person drives 15,000 miles per year, and an average cost of $2.628 per gallon of gasoline, we can derive the following facts:

If the average purchase of gas is 15 gallons, this means 15,933,333 fewer fill-ups per year, or 23 less fill-ups per person per year.

Assessment of Benefits

I question the immediate economic benefit of this program.  As a general principle, I do not favor programs that explicitly favor one industry over another.  It props up ineffective companies.  GM and Chrysler both were failing based on years of mistakes, and an economic stimulus to them does nothing to correct the underlying problems.

I do not believe this was an outright effort to “pay back” unions for their support of the Obama administration.  More purchases were made from non-unionized automakers than the Big 3.  There are more direct ways to reward those organizations.

The Financial Case Against the Program

If we look at the savings in gas as the main return on investment, the pay back period for this will be 4.58 years. The U.S. taxpayer is ultimately the one funding this incentive and from an individual investment standpoint, this doesn’t immediately appear to be a good decision. The general rule of thumb for automobiles – take out loans for no more than 36 months because you don’t want to have a loan longer than the expected life of your car – fails here. While newer cars are more reliable, and could be kept for longer periods, the average consumer buys a new car every 3-4 years.

Sales tax revenue will benefit local government, but will be less than $300 million. The net property tax benefit from this program may slightly increase, but these were trade-ins, not new purchases. The benefit from property tax rates will be the incremental difference in value between a clunker and a new car.

Sales Bubble

An original intent was to assist Detroit, but that benefit may be limited. Automakers with excess inventory were able to push vehicles through the supply chain. This clearly benefited distributors, but I question whether it will benefit automakers. There is a distinct possibility that this promotion captured all of the demand for new cars, and that sales will crater now that the incentive is gone. If that is the case, automakers will be reluctant to resume building vehicles that will sit on the lot.

The Case For “Cash for Clunkers”

On the other hand, this is an effective hedge against fuel inflation and places control directly in the hands of consumers. The savings from fuel are retained by the consumer, so household purchasing power would be increased by $909 per year.  If fuel prices increase – which is a highly likely event – this program shields participants from those inflationary forces. If we return to $4.00 gas, the pay-back-period for the program comes down to 3 years, and the consumer would save $1387 in fuel costs per year.

The most immediate beneficiaries of the program were dealers. The incentive not only stimulated overall demand for vehicles, it also led to higher average sales prices for vehicles.  Dealers saw both higher volume and profitability rates.

I suspect there was latent demand for new automobiles (people holding off due to recession), but many people would have purchased in the next 12 months regardless of an incentive. I’m not certain they would have gone for vehicles that averaged the 9+ MPG gain realized in this program. While this incentive encouraged people to purchase cars now, I think it may have encouraged them to buy slightly more efficient vehicles than they would have otherwise purchased.

The Unanswered Questions

The biggest question, whether this will help the U.S. automobile industry, won’t be known for years.  The stimulus was indirect and the benefit will depend on several other factors, including whether the economy picks up allowing for sustained consumption of automobiles.

What is the economic impact of the savings of $629 million per year? Not only is this money retained by the consumer, it is money that is not sent overseas in exchange of oil.  Will that have a higher economic benefit than other types of stimulus?

Will the improved fuel economy have negative secondary effects, such as decreased sales in convenience stores?  A 58% improvement in fuel economy also means a decreased need to visit the local gas station.

The debate around the long-term benefits of stimulus will likely influence future stimulus programs for years.  Let me know your thoughts.  I’ll continue to watch this space.

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