Wednesday, September 23, 2009

The Cash for Clunkers fallacy

Why are there so many people who claim Cash for Clunkers is an example of the broken window fallacy? It's not.

First, like everyone else has started, let's talk about the broken window fallacy. The story goes like this: A guy has a window. Someone throws something through the window, smashing it, and runs away. The guy now has to pay for a new window. Bystanders say, "Well, your window broke and you have to pay for a new one, but at least that money you're going to spend on it goes into the economy." Let's say that the new window costs $100, so now the economy is stimulated by $100. Is this the right way of looking at the situation? Is this an efficient outcome? Was the window being smashed a good thing, overall?

The answer is no. The guy had $100, which he may have spent on something else. Had his window not been shattered, then he would have a window and $100 worth of stuff rather than just a window. The guy would have spent the $100 on something to make him better off rather than being on par. With the window smashed, he now has a window and has effectively lost $100. He is worse off by $100, even though the economy is better off by $100. Had the window not been shattered, he'd be better off by $100, and the economy would still be better off by $100.

The bystanders have fallen into the broken window fallacy. Because the economy gets $100, they have assumed that there is an overal benefit. The argument is also applied to war and natural disasters.

Some opponents of cash for clunkers say that the program is an example of this broken window fallacy. They say that the destruction of cars isn't an overall benefit for anyone, and follows the same logic as the broken window fallacy.

There may or may not be an overall benefit of the cash for clunkers program--that topic is an interesting one, but it's a more complicated issue. It's certainly not an example of the broken window fallacy.

First of all, the destruction in the broken window fallacy refers to mindless destruction. It's a natural disaster, a force majeur, or an act of God, it's not something we choose. In the cash for clunkers program, people give up their cars to be destroyed, and the cars must fulfill certain requirements.

More importantly, in the broken window fallacy, the owner of the window did not want his window broken, because it makes him worse off. In the cash for clunkers program, the owner of the car willingly gives his car to be destroyed because it makes him better off. He effectively trades his car to get a discount on another car of his choice among a selection. If he doesn't want a car from the selection, he doesn't have to give up his car. The car owner makes the decision. He likely would have bought a new car anyways, were the new car cheaper than the original sticker price. The government merely provides the discount.

Why does the government provide the discount? Maybe they believe there's some benefit in carbon emissions, or maybe they want to spur the auto manufacturing industry, or maybe a number of other issues. The important issue is that the program will hopefully provide some effect the government want to attain.

So, is the cash for clunkers program a good program? Well, presumably, the car owners are better off, and the government is better off (having their desired effect come into fruition). Is everyone better off? It's hard to say, there will be some effect in the real economy and there will be some effect in carbon emissions. Were the taxes worth it? That's for someone else to figure out.

3 comments:

Cars4Charities said...

Cash for clunkers did nothing for the car industry or the environment. It just took 700,000 cars off the road and cost auto repair shops, taxpayers and car donation charities a lot of money.

Jdvn1 said...

You are very likely wrong that cash for clunkers did nothing for the car industry. Do you disagree with the idea that when the price of something goes does, more people buy it? The cash for clunkers program is an effective lowering of price.

As for the environment, there is likely an effect to the environment when more fuel-efficient cars are used. How much of an effect, I can't be sure.

Any overall effect to the average American has yet to be decided. So far, stimulus has seemed to help, though the effect of this particular program is unclear.

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