Wednesday, February 03, 2010

Cash for Clunkers: A Good Deal?

The cash for clunkers program cost tax payers $3 billion. In exchange, 700,000 Americans were able to get a new car at below market rates. Was this a good deal? Are there better ways to allocate this capital?

When making a cash outlay, one of the first questions should be to understand whether the money is being invested or spent. Expenses are things such as movies or dinners which have no residual economic value. Investments are things such as houses or stocks which generally have substantial residual, and even increasing, economic value. Cars are an interesting hybrid as they have residual value, but unless it becomes a collectors item, depreciates quickly and if not fully realized as an expense now, will become an expense as it’s fully depreciated over future years.

Providing discounted cars to a subset of Americans is something that benefits the few and has small, if negligible, ongoing economic value to the larger populace. The program was justified through the benefit of less pollution and better energy efficiency which benefits everyone, as well as spurring more auto sales to help struggling US auto makers.

If these are our goals: improve energy efficiency, reduce pollution, and help US auto makers, is there a better way to spend $3 billion? Rather than a one-time stimulus that benefits the few (one in 500), is there a program that can have on-going benefits for all Americans?

Tesla Motors, a US manufacturer of electric vehicles, recently announced installing five charging stations between San Francisco and LA so that their flagship car, the Tesla Roadster which has a 250 mile range, can make the trip. Total cost for these 5 charging stations: about $10000 each on average.

The energy dispensed by the charging station is free, justified by local merchants who foot the bill by driving traffic to their establishments. Roadster owners, who stop to charge their cars for three hours, will likely engage in commerce near the charging station. The cost of the electricity to charge the Roadster is around $2, so the merchants are paying $2 to have a potential customer in the vicinity for several hours looking for something to do.

Suppose we used the $3B for the clunkers program and built out electric charging stations instead? Could that achieve our goals of improving energy efficiency, reducing pollution, and helping US auto makers?

There are around 110,000 gas stations in the US. At the current price of $10,000 per charging station, we could install about 30,000 charging stations around the US. Assuming economies of scale, it’s not hard to imagine that 100,000 or more charging stations could be installed for the price of the clunkers program.

If we assume 50% or more of the cost of installing a charging station is labor, such a program would create a number of jobs, directly helping unemployment.

What we are left with is 50,000 to 100,000 free charging stations, subsidized by local merchants, to drive traffic to their stores. But what good does this do? Very few people can afford a Tesla!

This is actually where the large benefits take place. Over the last year, I have seen numerous companies that are building electric vehicles: bikes, motorcycles, and cars. In fact, there are over 100 companies that have been started to just build electric cars. With free charging stations covering the US, consumers will be very interested buying a new electric vehicle that takes advantage of this handout. And a number of entrepreneurs will be focused on building vehicles that can exploit the new grid, from a consumption as well as generation and storage standpoints. In short, we have created a new innovation platform.

But how do automakers benefit? Here we can look at other industries that have undergone a large technology leap, and examine what has happened. Recently, mobile phones went from being able to simply make basic calls to having cameras on them. This caused a rapid upgrade cycle, moving the average time a consumer keeps his phone from 24 months down to 18. The widespread availability of wireless data networks and high quality phone software is now causing another upgrade cycle to devices such as the iPhone and Android.

Whether these upgrades are captured by the existing players or new players depends on how well the companies are run, but in any case it’s a huge boon for the players who can get it right. Just look at Apple’s stock price or the buzz Google is getting for its Android operating system.

With this approach, for the same $3B, we would have:
• a national charging grid that enables electric vehicles to be charged at as many locations as the corner gas station
• an opportunity for merchants to drive traffic to their stores by subsidizing the energy using to charge the vehicles
• a massive upgrade cycle as entrepreneurs and consumers find innovative ways to use the electric grid
• a spike in employment as factories, stores, and other infrastructure are upgraded and built to fulfill the demand for electric vehicles
• much cleaner environment, as electric power is substantially cleaner than the internal combustion engine
• most likely, safer roads, as electric vehicles tend to be lighter and built out of modern materials
• drive innovation in battery and grid storage technologies, reducing costs and further increasing efficiency
• a tremendous opportunity for existing as well as new vehicle manufacturers to fill the demand to drive profits and employment

Rather than allocate another $3B, this program could be paid for via a national gas tax of two cents/gallon. This would further incentivize consumers to move toward electric vehicles since it would further pressure operating cost differences between gas and electricity, and bring prices closer in line with true costs, when deficits, national defense and pollution are taken into account.

Overall, upgrading the grid is likely a much better way to invest tax payer dollars and reap long term rewards compared to subsidizing car purchases for Americans who own “clunkers”.

US uses 9.3M barrels a day
42 gallons of gas per barrel

Removing clunkers will save 5M barrels a year

Chargers cost 7-12k each
Subsidized by local merchants

John Mauldin 12/4/2009 newsletter:
All we did with this "Cash for Clunkers" thing was move cars forward that would have been bought later. You're not increasing sales down the road. Yeah, you're taking cars off the road and spare parts and stuff, but I think it's kind of a silly investment in dollars. But, what's $3 billion when we're wasting a trillion here and a trillion there? Still, it's disappointing.

Bruce Leak 12/9/2009 email:
Politics isn't about efficient use of capital. It is about special interest groups and playing to populace emotions. Subsidizing "green" car purchases pleases car manufacturers, suppliers, finance institutions, labor unions, dealers, environmentalists, local and state tax authorities, scrap recyclers and consumers. What's not to like?