Cash for junk, will it revive economies?

The global economic crisis has created a cascade of financial problems.  Banks won’t, or can’t, lend.  Consumers move to protect their incomes and stop spending.  Retailers order less stock and lay off staff.  Manufacturers produce less, and lay off staff.  Which produces fewer consumers, who spend less.

The cycle repeats with production being chased down by falling spending.  Governments have responded in a number of ways: by increasing government expenditure on large state-driven projects, like healthcare or infrastructure or IT; by lending vast amounts of cash to banks at low interest rates with the proviso that they then lend to consumers; by intervening directly to give cash to consumers.

The latter’s most obvious example is that of the “cash for clunkers” program in the US, and the similar “scrappage” scheme in the UK.

The principle is straightforward.  Motor manufacturers are large employers and they are in danger of collapsing under the weight of inventories and falling demand.  Car owners who possess old, fuel-hungry vehicles (“clunkers”) will be given a significant discount on new cars if they scrap their old one.  The scrappage ensures that the old cars don’t simply end up in the secondary market where they would depress prices.

Car makers get to sell new cars.  Governments get to promote employment and investment, while also reducing carbon emissions from old cars.

The scheme has proven popular.  In the US, car owners get $4,500 towards the purchase of a new car.  The $1billion allocated to the program – equivalent to over 220,000 cars - was gone in 10 days.   In the UK, owners get only $3,200 but already over 150,000 new cars have been purchased.

It would seem to be working, wouldn’t it?  The US government is convinced and has promptly allocated an additional $2billion to the scheme, equivalent to almost 450,000 more cars.  This is a small, but significant, proportion of the 16 million cars sold annually in the US.

There are many arguments against the incentives.  Many people would have bought cars anyway. Vehicle prices have been reduced and the sales period has been compressed so that sales that would have been spread over a year are now taking place in one month.  All tax payers are subsidising the new cars of a few.

These are all fair comments.  I’ll add a few more.  It won’t stop the long-term trend for consolidation in the motor industry by bailing out a few.  The amounts involved are small and will only allow for temporary relief.

But even that is misleading.  It gives the impression that supporting an economy involves supporting specific industries within that economy.  The truth is that the motor industry suffers from tremendous over capacity that is the result of perpetual bail-outs.  By choosing a single winner, governments do their people no favours by “forcing” workers to remain in failing industries.  The money would be better spent reskilling people to work in new industries.

Which new industries?  Good question, but we won’t find out by chucking all our energy and cash at industries that aren’t working.

Markets may fail, but their capacity for constant reinvention and experimentation ensures that new ideas can become successful as old ideas are found wanting.  By picking individual industries, governments are stating, unequivocally, that they believe consumers are wrong and should be paid to keep buying things they may not want.  That’s what caused the crisis in the first place.

So, how do we break that cycle of consumers not spending?  How do we identify which industries are wanted, but without supporting them directly to make sure that those that are on the way out leave?

It’s unpalatable, but we have to keep supporting the banks.  This is not to support banking as an industry, but in their function as lenders to consumers.  For, ultimately, it is consumers who must decide what they want.  And what they don’t.