Petrol-head economics!

The recession and financial crisis has brought about a plethora of initiatives to kick start the US economy. However, amongst all the headline grabbing measures to save the US economy from a depression like era, the measure which has almost been lauded as saving the car industry and getting growth on track has been the recently heralded “Cash for Clunkers” stimulus package or CARS Act (Consumer Assistance to Recycle and Save bill).

One noteworthy populist quote was that “this legislation will help consumers, stimulate our economy, improve our environment, reduce our dependence on foreign oil, and help our domestic auto and related industries, upon which millions of American families depend on for employment”. How about that?

The car stimulus package, which had in fact been waiting in the wings since March, was rapidly introduced following the announcement that US car sales had fallen by over 40% from the previous year, a steeper fall than in the early 1980s, and after both General Motors and Chrysler sought bankruptcy protection in June. The scheme was initiated with the bold promise of taking older gas guzzling cars off the road and spurring new car sales, by giving the consumer buying incentives for turning in cars that are eight years or older to buy more fuel efficient vehicles.

The bill provided graduated incentives based on greater fuel efficiency. Details of the plan, to give them some colour, were based on the difference in fuel efficiency of the old car for a new car. If by buying a new car fuel efficiency was improved by 10 miles per gallon, a tax credit of US$4,500 was given. But if the improved fuel consumption was more than four miles but less than 10, then a tax credit of US$3,500 was given.

The package follows a similar successful concept in Europe, as the UK, France, Germany and Italy all have their own schemes. The plan was initially for just US$1 billion, but after this sum ran out after the first week due to heavy demand a further US$2 billion was added. The rebate scheme in all lasted from the 27 July through to 24 August. It cannot be said for a moment that its initial impact has been unsuccessful.

The programme saw a surge of buyers in dealer showrooms in August, lifting sales dramatically above previous year levels for the first time since October 2007. US July/August sales reveal that sales ran at a rate of 11.5 million cars on an annualised basis, up from an average of 9.8 million during the previous seven months. The previous decade averaged 15 to 16 million cars.

BUT – now comes the hangover. Whilst short-term sales may have been lifted it is widely expected that the next few month’s car sales will drop just as swiftly. In fact, hot off the press we understand that car sales in September fell 23% and disappointingly GM’s sales in September fell 45%. Also, the effect of this directed stimulus package is that it has just borrowed from future growth and could also be to the detriment of other consumer goods. We understand that the US car industry ranging from manufacturers to dealerships, distributors and suppliers employs some 2.5 million people and therefore, clearly it is sizeable.

Cynically, the help provided by the Government is hardly selfless, given their now vested interest and stakes in the industry through GM (60% owned) and Chrysler (8%). Unfortunately, research analysts have revealed that the scheme was, in fact, so far reaching as to boost demand for Japanese manufacturers’ cars at the US expense, with the domestic big 3 - Ford et al, only sharing 38.3% of the cars bought through the programme. Talk about shooting yourself in the foot.

So are the results of this programme going to achieve the lofty hopes of the politicians? It appears doubtful, however, but on a brighter note, and despite the domestic companies’ lack of participation, it is estimated that there will be a strong impact on third quarter GDP. Current estimates are for a revival of growth to 2% in the third quarter (second quarter was -0.7%) and it is entirely possible that the increased activity (albeit short-term) could in fact have increased US GDP by a further 1%, as motor car and parts account for 3% of total GDP.

This may be sufficient to give a short-term boost to market sentiment and consumer confidence and to smooth growth out over a rough patch when demand has been particularly poor. When all is said and done, it does appear that the US Government is prepared to jump through most hoops to ensure a revival in growth, and this latest measure is unlikely to be its last.