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Sunday, March 29, 2009

Cash for Clunkers

Here is an op/ed originally published in the Richmond Times-Dispatch on February 14, 2009 entitled "Detroit's Drop-Dead Day". Go here to see it on their site.

LEXINGTON [Virginia] When the good news is that Honda's U.S. sales are down only 28 percent and Toyota projects losses of only $5 billion, it's clear the auto industry's problems extend well beyond Detroit. Market pro jections by car companies for 2009 vary by 30 percent, while light truck sales are up -- for now. Which cars will sell is no clearer than how many will sell. Yet, in its December "bailout" to the industry, Congress mandated that Detroit produce turnaround plans by Feb. 17 and show progress in implementing them by March 31, or get thrown into bankruptcy.

The reality is that credible planning is impossible. And in an industry with high fixed costs from parts producers -- which employ three times as many workers as the car companies themselves -- down to dealerships, a 40 percent decline in sales means everyone is losing money. Those without a cash cushion will go under. In the past few months 40 suppliers have declared bankruptcy; hundreds of dealerships have closed their doors. The entire "value chain" of the industry is in parlous health, but is so interconnected that if too many firms fail, the normally orderly process of bankruptcy will spiral into a chaotic shutdown of all manufacturing, taking with it 1 million jobs in short order.

LET'S BE frank: There are no easy solutions. Improved engineering processes allow firms to launch new products more rapidly than ever. A vehicle that sells well soon faces competition from all sides. Even before the recession, chronic excess manufacturing capacity and bloated dealer inventories plagued the industry. One indication was the launch by the Japanese and Germans of SUVs and pickups, which they've found hard to sell. There's been excess capacity across producers and product segments, and not just in Detroit.

Then came the bubble. During the four years leading up to our current downturn, the stock of vehicles expanded by 22 million units, leaving us with 248 million vehicles for 202 million drivers. Now population growth adds 2 million drivers a year, and expanding businesses top that off with another million units of demand. The market might more reasonably have grown by 12 million units -- not by 22 million. The overhang created by the bubble isn't just in housing.

One temptation is to try to pile on government-financed incentives. But as the industry well knows -- and the Detroit Three know better than most -- artificially boosting demand with discounts and sales to rental car fleets carries a steep cost: It "buys" sales from the future and leads to an outpouring of used cars a few years down the road. So purchasers receive poor prices on their trade-ins. That, in turn, leads to a perception that these vehicles are low in quality when, in fact, poor trade-in prices reflect supply-and-demand. Incentives thus come back to bite the industry, but high levels of discounting are addictive, as sales plummet the moment they're removed.

ONE POLICY that might help is a version of "cash for clunkers." This would help eliminate the market overhang created by the bubble to get rid of old cars rather than trying to pile on more new ones. To make sense, however, it must really be targeted at clunkers -- and hence should offer more cash for older vehicles. It might start at $500 for a 10-year-old vehicle, bumping the payment up $100 per year, with $1,500 for vehicles aged 20 and above. The new Department of Transportation vehicle tracking system would help ensure that these vehicles are recycled into scrap, and DOT and the EPA also have the expertise to jiggle the details to get rid of a target number of vehicles (say, 2 million).

This policy would be no panacea; if pursued too aggressively, it could make it harder for lower-income Americans to buy a vehicle. Nor are all old cars inefficient; the subcompacts of the 1980s got tremendous mileage. Owners might prefer to drive such clunkers rather that accept cash. But unlike other proposals, this policy would not distort new car purchasing decisions and would thereby avoid another downturn in sales the moment the program ended. Improve access to finance for credit-worthy borrowers, yes! -- and the recent targeting of TARP funds to the finance arms of General Motors and others has helped. But to offer an alcoholic strong drink -- that is, to pile on more discounts -- not only won't work: It's just plain wrong.