A student in my managerial economics course asked me a very interesting question today concerning the U.S. federal government’s “Cash for Clunkers” (also known as “CARS”, which is an acronym for “Car Allowance Rebate System”) program. Specifically, she was interested in knowing how to assess the social costs and benefits of government programs like CARS from an economics perspective.
Let’s look at CARS and its cousin, the so-called “first-time-home-buyer tax credit” (FTHBTC). It’s worthwhile reading the October 28 Edmunds.com article about the economics of CARS. Apparently the net cost to taxpayers of CARS, per marginal sale, was $24,000. Coincidentally, MIT economist (and former IMF chief economist) Simon Johnson published a Washington Post article about FTHBTC earlier this week which reports a net cost to taxpayers of FTHBTC of between $43,000 to $80,000 per marginal sale. Thus the net effect of both policies has been to create a rather muted, temporary, and highly inefficient stimulus at a substantial cost to the taxpayer (the same points could be made about any number of other stimulus measures taken this year by the U.S. government, but I digress). Professor Johnson notes (and I agree) that “Putting cash in pockets does have a stimulative effect because some of that cash will turn into consumption. But as far as stimulus measures go, it has a low multiplier (the ratio of new economic activity to stimulus spending).”
In the case of CARS, a social cost of $24,000 provides a maximum net private benefit of $4,500 (note that the clunker would have to be literally worthless in order for the net private benefit to be equal to $4,500!), and in the case of FTHBTC, a social cost of $43,000 – $80,000 provides a maximum net private benefit of $8,000 (note that since the FTHBTC is means-tested, the average net benefit must be less than the $8,000 maximum). In the case of FTHBTC, Professor Johnson asserts (and I agree), that most, if not all of the private benefit (i.e., additional “surplus”) is enjoyed by the seller of the home in the form of a higher price than she would have otherwise received from the buyer in the absence of the FTHBTC. With the FTHBTC, the buyer will naturally become less reticent about paying top dollar for owner-occupied housing because up to $8,000 of the price is covered by taxpayers (also note that other public policies such as the tax deductibility of mortgage interest and mortgage securitization by the likes of Fannie Mae, Freddie Mac, the FHA, et al. have similar effects with respect to inflating the value of our nation’s housing stock). For these very same reasons, I also suspect that much of the “surplus” associated with CARS ended up benefitting sellers by making new car buyers less price sensitive than they otherwise would have been.
Finally, bringing this question “closer to home”, I often think about the economic effect of government subsidies on higher education. To the extent that the government subsidizes tuition (e.g., in the form of scholarships and below-market interest rates on student loans) this also has the effect of increasing the producer surplus enjoyed by universities by making students and their families less sensitive to price. I am convinced that an important reason why education costs generally and higher education costs specifically have been increasing faster than overall inflation for some time now is due to the role played by government subsidies. There’s also an obvious cautionary tale in all of this for health care reform, but I’ll leave that to a future discussion.
Tonight on ABC’s 20/20 program, the entire show will be devoted to SuperFreakonomics (subtitled “Global Cooling, Patriotic Prostitutes, and Why Suicide Bombers Should Buy Life Insurance”). SuperFreakonomics is the recently released sequel to Freakonomics (subtitled “A Rogue Economist Explores the Hidden Side of Everything”) which appeared in 2005. The authors of both books are Steven Levitt and Stephen Dubner. Levitt is an economics professor at the University of Chicago and the 2003 winner of the John Bates Clark medal (“awarded biennially … to that American economist under the age of forty who is judged to have made the most significant contribution to economic thought and knowledge”; for what it’s worth, roughly 40% of the Clark medalists have subsequently received the Nobel Prize in economics). Dubner is an award-winning author and journalist who lives in New York.
Anyway, tonight’s 20/20 program will air five segments, all of which can be previewed online: handwashing in hospitals, the effectiveness of car seats, how practice trumps talent, the dirty truth about altruism, and the problems with global warming. If you’re interested in following the Freakonomics blog, it is located at http://freakonomics.blogs.nytimes.com.
I would like to call everyone’s attention to a formal online debate concerning executive compensation which began on Tuesday, October 20 and is scheduled to conclude on October 30th. Later in the semester, we’ll discuss how to structure compensation to align incentives between owners and managers of firms. However, this debate, which is sponsored by The Economist, addresses the ongoing public controversy concerning whether senior executives are worth what they are paid.
Specifically, the motion reads as follows: “This house believes that on the whole, senior executives are worth what they are paid.” The person defending the motion is Steven N. Kaplan, who is the Neubauer Family Professor of Entrepreneurship & Finance at the University of Chicago Booth School of Business. Professor Kaplan may very well be one of the most widely published and prolific scholars on the topic of executive compensation. The person who is against the motion is Nell Minow, who is Editor and Co-founder of The Corporate Library, which is an organization that bills itself as “…the leading independent source for U.S. and Canadian corporate governance and executive & director compensation information and analysis”. Anyway, this debate should certainly be interesting to follow!
I would like to call attention to a short article entitled “Swine flu vaccines and elasticity of supply”. The author of this article, Geoff Riley, claims that most of the swine flu market is being contested by only four companies: GlaxoSmithKline, Sanofi-Aventis, Novartis AG and AstraZeneca. He also notes that “For students of the price mechanism it is a fascinating example of many supply and demand concepts at work: the challenge of scaling up production to meet huge levels of demand – this has involved out-sourcing, the relative importance of fixed and variable costs in developing and manufacturing/distributing a new drug, the elasticity of supply of vaccines to meet short term health requirements, the oligopolistic race to win and protect market share, economies of scale in production, the balance of power between the major buyers and the multinational drug suppliers, price discrimination tactics.” I hope that Mr. Riley will expand further upon these topics in future blog postings. If he does, I will be sure to pass this information along.
It appears (to me, anyway) that the U.S. is not all that well prepared this time around for either the seasonal flu or the swine flu. Both types of flu appear to be in full swing, and yet there are pervasive shortages of both types of vaccines. I can only hope that the situation does not deteriorate as badly as it did in 2004, which was the last time that a major vaccine shortage occurred. Back then, the U.S. government had contracted with just two companies, Aventis (now Sanofi-Aventis) and Chiron (now a division of Novartis AG), for each firm to supply roughly 1/2 of the entire U.S. flu vaccine market that year. The problem then was that in early October 2004, the UK’s Medicines and Healthcare Products Regulatory Agency (MHRA) suspended Chiron’s license to manufacture influenza virus vaccine in its Liverpool facility, which in turn prevented the company from releasing any of its flu vaccine product during the entire 2004-2005 influenza season. In fact, the shortage became so severe in the U.S. that by late October 2004, numerous articles began to appear touting medical tourism to Canada for the purpose of getting vaccinated for the seasonal flu; e.g., see my 10/27/2004 blog entry entitled “Some Canadian Flu Shot Alternatives”. Considering that (according to the Centers for Disease Control (CDC)) seasonal influenza by itself typically accounts for 140,000 hospitalizations and 40,000 deaths per year in the United States, this demonstrates how hazardous it can be to rely upon such a small number of suppliers.