February 28, 2009

Scrap Logic

The car scrap premium proposal of Frank-Walter Steinmeier, Germany’s foreign minister, was approved by the Federal Government, but yet the question is, does it make sense?
To stimulate the automotive industry by increasing sales of new cars, people receive a $3.000 payment to scrap their car, that is 9 years or older, in order to buy a new car (that fulfils the new emission standard Euro-4).

John Maynard Keynes ironically stated, that in times of recession, the government should “fill old bottles with bank notes, bury them at suitable depths in disused coal mines which are then filled up with town rubbish, and leave them to private enterprise on the well-tried principles of laissez faire to dig them up again.” This could have the same effect as the new scrap premium.

In order to be effective, it has to encourage enough people to make an impact.
It is questionable, if the premium actually encourages people, to destroy their car and buy a new one.
On the one hand, it would help the decision of car drivers who have already thought about purchasing a new car. I would consider this number of people as relatively low.
On the other hand, in times of the financial crisis, it is unlikely that a car owner is willing to buy a new one. Other reasons could be that he cannot afford a new car, does not want to buy one because of its relatively high opportunity costs, or still likes his car that is 9 years or older. An additional $3.000 increases the budget of the individual, but the purchase of a new car might still be beyond this new budget line.
A new car has a fast depreciation in value, especially in its first year. This is why there is a tendency to buy used cars. Buying a new car also faces higher opportunity costs because it binds the capital and fewer interest can be realized.

Therefore the base of new car consumers may be smaller than needed and the scrap premium would only have little impact for the automotive industry.

Another aspect of a policy’s intension should be the generation of value, while the car scrap premium reflects a destruction of value.
In my opinion, it is a shame to destroy cars, just because they are nine years or older, in order to get the premium,
even though they are still in proper running condition.
The premium causes an economic damage of the
rest value of the car plus the costs of search to find a new one.
Would it not be the same to blast houses in order to stimulate the building industry?

The reduction of CO2-emission represents another argument for the scrap premium.
By replacing old cars for newer, more fuel efficient ones, the premium is supposed to contribute to the reduction of CO2-emission and therefore to the protection of the environment.
However, I do not consider the solution using a premium as very effective and do not think it could result in a multiplier effect.
To achieve an ongoing effect, it is necessary to put incentives on the people’s
behavior. By charging car drivers with a CO2-emission price that is integrated in the petroleum tax, the individual can choose how much he is willing to pay more for the additional pollution.
Without negotiating with all other continents, I do not see a significant effect of reducing the CO2-emission with the premium. There is no local solution for a global problem like this.

Maybe this is not quite the area of responsibility for a foreign minister, and the government should consider theories of specialists of a more effective investment to stimulate the automotive industry and to protect the environment.



Larry Eubanks said...

Economic analysis generally relies on looking at the margin. I think your essay doesn't rely on thinking at the margin enough. If you think about the price at the margin, I think we can expect an increase in the number of new autos purchased. I don't know whether to expect a relatively large increase or a relatively small increase, but I do expect an increase.

Tobi Lenz said...

Well, Professor Eubanks, I agree that in total the premium would lead to an increase in car sales because it reflects a cheaper price. I did not question that because I do know that it helped Germany to increase their car sales by 21%.
All I am saying is that it might be ethically questionable to destroy value like this.
Scrapping should not be the solution. It would be a better wat to save the car parts at junkyards in order to repair older cars which are still in good running condition.
I also question that customers would receive additional value or utility in the amount that they are paying more for a new car.
Wouldn't it be just like asking the consumers to keep their old car and give the difference of the additional value and the high costs of a new car directly to the producers???