Next to “no free lunch,” perhaps the most important idea in an economics tool kit is “unintended consequences.”
Our story starts in Bogota, Colombia and a visiting professor who tells the Freakonomics people that his friends picked him up with a different car each day. Why? To minimize pollution, the government mandated that car owners could not drive daily. The check-up system? Your license plate. So, many of those who drove daily just used a different car that had a different plate. Less pollution? Not at all. In fact, because those additional cars were old, there was more pollution.
Our next stop is Mexico and a story we have already told. To elevate air quality there, people were encouraged to upgrade refrigerators to newer, more energy efficient models. What happened? Cheaper electric bills let them use their appliances even more.
And this takes us to Cash For Clunkers (aka CARS: Cars Allowance Rebate System, 2009). The source of the idea, Princeton professor Alan Blinder said it would be “trifecta” legislation. By giving a $3500 or $4500 rebate to people who traded old less energy efficient vehicles for newer ones…
- you helped the auto industry through new car purchases
- you helped the environment with elevated mpg requirements
- you helped the poor by making new cars cheaper.
What happened? The program was so popular that Congress had to add $2 billion because they ran out of rebate money.
- After a massive sales burst during the 2 months of the program, purchases plummeted. The program’s incentives time shifted sales decisions.
- The environmental perk did not materialize. Pick-up truck owners did not buy Priuses. Instead, they traded old gas-guzzling pick-ups for newer, lower gas guzzling trucks. In addition, fuel efficiency can lead to more driving and ultimately, any diminished emissions were a tiny proportion of the US total.
- And finally, lower income individuals might not have benefited because the older cars they could have afforded were traded in and destroyed. Fewer used cars meant less supply and a supply curve shifting to the left. Used car prices increased.
In Colombia, in Mexico, in the US, legislators had rational, valid objectives. But the consequences were unintended.
How can government get the best out of us? Your answers?
Sources and Resources: My reading for today was fascinating. I returned to the Michael Grabell book, Money Well Spent? and his chapter, “Cash For Clunkers.” More scholarly but very readable, a paper on the impact of Cash For Clunkers, written by economists Atif R. Mian (Princeton) and Amir Sufi (University of Chicago) was excellent. I got the idea for the post and my information on Colombia from this Freakonomics podcast and Alan Blinder suggests Cash For Clunkers (as “the best stimulus idea you’ve never heard of”) in 2008, here, in the NY Times.
Posted by: adminEcon
Tags: 2009 American Recovery and Reinvestment Act, Alan Blinder, Amir Sufi, ARRA, Atif Mian, cash for clunkers, Colombia, Freakonomics, Keynesian economics, Mexican refrigeration, Michael Grabell, Money Well Spent?, stimulus spending, time shifting
Hearing Kermit the Frog say, “It’s not easy being green,” Mexican environmentalists might agree.
Since March 2009, Mexican households have been offered cash payments or subsidized loans for replacing refrigerators and air-conditioners that were more than 10 years old with new energy efficient appliances. The goal was to diminish electricity usage and carbon dioxide emissions. So far, 1.5 million households have participated.
Surprisingly, refrigerator savings were less than expected and air-conditioner use increased. Researchers believe that newer refrigerator models were larger and had extra features like ice makers that somewhat offset their energy savings. For air-conditioners, people just used them much more.
Energy savings programs are tough to design and evaluate. As with refrigerators and air-conditioners, changing incentives can have unpredictable consequences. In addition, even if an energy savings program does not save energy, it still could provide considerable benefits far beyond its costs because of better refrigeration and cooler homes. And finally, we should always remember the “rebound” effect. Explained by William Jevons in an 1865 book called The Coal Question, the “rebound” effect resulted when the energy efficiency created by the steam engine encouraged more energy use rather than less. Jevons said, “It is wholly a confusion of ideas to suppose that the economical use of fuel is equivalent to a diminished consumption. The very contrary is truth.”
Maybe Kermit was right.
This NBER paper fully describes the Mexican cash for coolers program and if you want to read more about the rebound effect, I suggest this fascinating New Yorker article. For a more academic study, this Congressional Research Service (CRS) report explains that the “rebound” effect is most evident in a developing economy because slack demand can lead to considerable increase in energy use. In a mature market, the “rebound” effect is less pronounced.
Posted by: adminEcon
Tags: air-conditioners, American Recovery and Reinvestment Act of 2009, carbon dioxide emissions, cash for clunkers, cash for coolers, cost/benefit, developed nation, developing economy, emerging market, energy efficiency, environment, green, Mexico, negative externalities, price elasticity of demand, rebound effect, refrigerators, stimulus
It would be so nice if we could say, “Yes, the 2009 stimulus was a good idea,” or “No, it was not.” Instead, the debate continues.
Discussing his new book, journalist Michael Grabell tells us that we are unnecessarily dividing ourselves between government believers and disbelievers when the focus should be on designing programs that work. Grabell says the problem was not the $787 billion. Stimulus planners chose the wrong “shovel ready” projects. States were unprepared for a tsunami of money. As a whole, the initiative had inadequate “oomph” to create a sustainable recovery.
Where did it work? He says to look at Cash for Clunkers, the program that paid us to trade in our old, emission spewing jalopies for new models. Grabell says the program successfully stimulated car production and supported car dealers.
Not everyone agrees.
An op-ed in the Boston Globe described why stimulus dollars made used car prices soar. On the supply side, car dealers had to destroy the old gas guzzling vehicles they received. On the demand side, with joblessness soaring, more people needed cheaper, “pre-owned” transportation. Less supply? More demand? Equilibrium price rises.
As you can see, the facts abound to applaud or condemn the impact of the 2009 Stimulus Act . Sometimes I even wonder which comes first, the facts or the conclusion. Exhibiting “confirmation bias,” first we walk in with our bias, and then we find a slew of facts to support what we believe in.
The Economic Lesson
In his General Theory on Employment, Interest, and Money, British economist John Maynard Keynes said that nations should borrow during a recession. Then, by using the money to “prime the pump”, fiscal activism stimulates business expansion, the recession ends, government revenue surges, and the debt is repaid.
An Economic Question: How might “confirmation bias” affect your economic analysis about the impact of government spending?
Economics always seems to relate to incentives. Whether looking at demand and supply, or health care policy, or international trade, always we can return to how incentives shape our behavior. This takes me to several good incentive stories.
An op-ed in the Boston Globe recently described why used car prices are soaring. As a part of the cash for clunkers program, old gas guzzling, fume emitting vehicles had to be destroyed by car dealers when their owners had the incentive to trade them for newer vehicles. The upward sloping supply curve for used cars responded by shifting leftward. In addition, with joblessness soaring, when more people sought “pre-owned” transportation, the demand curve shifted to the right. The result? Equilibrium price is higher.
In 1989, Mexico initiated a pollution reduction policy for autos. One day weekly, depending on the last number of your license plate, you could not use your car. Incentive? Acquire a second car. Minimally used, that car could be older and less fuel efficient. The second response? Find a second license plate for your car. Third response? Use a taxi. As you might conclude, overall air quality did not improve.
Here is an 18th century story from Planet Money where government ultimately figures out the correct incentive. Hearing that close to one third of all felons died when they were shipped by sea to Australia from Great Britain, people were horrified. They demanded more onboard doctors, added lemons to cure scurvy, and delivered sermons encouraging moral behavior. Nothing worked until the payment system changed. “Instead of paying for each prisoner…on the ship…” the government paid for whoever “…walked off the ship in Australia.” Adopted in 1793, the new incentive solved the problem.
The Economic Lesson
If anyone suggests that economics is primarily about money and math, you could suggest looking further. At the core of economics is scarcity. Because there are limited quantities of all land, labor, and capital, we have to make choices. Incentives shape our choices.