The New Plan to Save the Auto Sector

In a press release dated April 9, the Administration announced a new plan to help the auto sector. By June 1, they plan to purchase 17,600 new vehicles for the Federal fleet. The purchase has two purposes. The first is stimulus. By accelerating the purchase of the cars, the administration hopes to support the auto industry. And since the contract is for purchase of GM, Chrysler, Fords, it helps American manufacturers. The second is fuel efficiency. By trading in less efficient cars for more efficient, the government can reduce both its gasoline consumption and its carbon emissions. It’s not clear from the release how quickly this replacement would have happened in the absence of the stimulus plan. So, it is difficult to measure the full benefit of the plan.

Cars are currently selling at a pace of about 9 million per year. The federal purchase then provides a boost of about 0.4 percent in the first six months of 2009, helpful but not a solution to all of the car companies’ woes.

This, by the way, is exactly the type of stimulus spending of which I approve. The spending brings forward government demand to the period where it is most needed. The additional costs of the program are small and consist mostly of reducing the average age of the government’s fleet. And, the scale of the program, while significant, is unlikely to have a first order impact on prices. That is, the crowding out effect is likely to be quite small. If only the government could spend the full trillion in such a manner.

Of course, the plan does not stop here. The administration wants a tax credit for anybody who wants to trade in an old car in exchange for a new one. This plan would be sold as a fuel efficiency plan but would of course have the primary intent as stimulus.

What are the impacts of a broader plan?

Many countries around the world are currently implementing similar plans. The German government offered a €2,500 incentive for anybody who traded in a 9 or more year-old car for a new vehicle. I don’t have the numbers in front of me but the plan was apparently quite successful. New car sales surged in Germany. Similar programs with similar success rates were implemented in France, Italy, and, I believe, Brazil.

To pro-stimulus economists, these programs are a glowing success. The government implements a rebate program designed to boost demand and it works. We can easily measure the number of new cars sold, compare it to some baseline, and we can judge the program a success.

What we can’t measure is the costs of the program. I don’t mean the fiscal cost, that is easy. I mean the economic costs. The government has introduced a real relative price change in the economy—new cars are cheaper relative to other goods.

Real relative price movements change the allocation in the economy. People substitute towards cars. The substitute away from …

That is the problem. We don’t know what good or service households stop consuming because of the cheaper cars. It has to be something. The government may be flexible about its budget constraint the household cannot be. (The government can raise taxes or print money; the household cannot simply demand higher wages.)

The German new car sales numbers are for March. Retail sales around this time are likely to be smaller than they would otherwise have been. Once again, we have no counterfactual and so cannot estimate the crowding out effect. I suspect, though, that we will find German and French retail sales disappointing relative to Dutch, Danish, or Spanish sales.

Takeaway: The administration’s plan to purchase new energy efficient cars is a good plan. The scale is right and the plan is likely to help the car companies some. Rebates to induce sales seem ideally suited to replicating the program only on a bigger scale. These programs, however, create important distortions in the economy; distortions we cannot fully measure.

Moreover, even the hint or the rumor of these programs distorts the economy today. If you have not yet read Casey Mulligan’s blog on this topic, do so now (put the link here). The rumor causes households to postpone the purchase of cars. Because my trade in might be worth substantially more tomorrow, I will wait to purchase a car until tomorrow. Since we do not know the parameters of the program, this wait and see effect will influence a large cross section of potential new car purchasers. Just as now, many taxi drivers in Chicago are waiting to purchase their new cars because the city council might subsidize them at some point in the future.

Here the German’s beat us to the punch in terms of efficiency. Almost before German citizens knew the policy was coming, the German government passed the rebate.