Fund Strategy – Strategist Feature
29 October 2009
As the scale of the economic slowdown intensified at the end of 2008, authorities round the world were faced with increasingly challenging choices. Consumer spending is the main driver of economic growth in the developed world and the consumer was not in good shape. Unemployment was rising, wages were under pressure and confidence was plummeting. It was a vicious circle that could only intensify, at least in the short term, without government help. Now, when governments act, they often look for the most obvious path. As spending on cars and houses make up about two thirds of total consumer spending, these areas were unsurprisingly the focus for some major government policy initiatives. The key question now is: have they worked?
The authorities rightly judged that whatever initiative they came up with had to involve actual ‘consumption’. Tax cuts or rebates will not necessarily boost spending, especially in a period of great economic uncertainty and highly-geared households. In such circumstances, the financial windfall is more likely to be saved than spent, diluting the impact of the initiative. Consequently, the incentives in both the housing and the auto industry have been dependent on actual spending.
We will principally consider the measures taken in the US, but the conclusions or observations could apply to any other economies that have adopted similar schemes. Firstly, we will consider the so-called ‘cash-for-clunkers’ (CFC) scheme. Secondly, we will look at the tax credit incentive to boost first time buyer (FTB) demand for housing, and other housing market initiatives.
All the CFC schemes share the similar characteristics of involving a financial incentive to scrap an eco-unfriendly model of car and replace it with a new eco-friendly model. The auto industry was judged to be a suitable target for assistance because if it failed it would have significant consequences for unemployment, not just in the car assembly plants, but also in ‘parts and materials’ suppliers, car showrooms and the other extensive beneficiaries of a healthy car business. Apart from the US eleven of the euro zone’s 16 countries have, or plan to have, such a scheme.
In the US, the scheme ran for about a month, during which car sales were estimated to have risen from an annualised rate of 9.7 million, in the month before the scheme was introduced, to over 14 million. It would be convenient to subtract one from the other to gauge the effectiveness of the scheme, but that would not tell the whole story. Many purchases would have taken place anyway, so it is difficult to assess the incremental impact and cost of the scheme. More importantly, it is highly probable that the scheme will only alter the pattern of sales, bringing ‘future’ sales forward, but having little incremental impact overall. It is also argued that its wider economic impact will have been minimal, as the scheme will have ‘crowded out’ the purchase of other items.
The ECB has been highly critical of the European schemes for a number of reasons, including the judgement that they are likely to have no lasting benefit. More specifically, they reason that the schemes could interfere with the workings of the free-market economy and ‘delay necessary structural change’. Certainly, it is estimated that there is a production overcapacity of 30 million vehicles world-wide suggesting that structural changes are required to adjust supply more closely to demand. Toyota, for one, is planning to cut its production capacity by 10%, but others are less prepared to adjust and could have seen the CFC as a convenient opportunity to slim their bloated inventories to make way for renewed production.
The effectiveness of the $8,000 tax credit for first time house buyers (FTB) in the US is even more difficult to evaluate. Home sales (both new and resale) totalled just over 5 million, at an annualised rate, in December 2008, the month prior to the start of the scheme. The latest figures we have show that in August total sales had risen to over 5.5 million. As with the CFC, it is exceptionally difficult to gauge the precise contribution of the tax credit scheme. In the UK, the authorities introduced a ‘stamp duty’ holiday for homes costing up to £175,000.
Nevertheless, demand for housing in the US would probably have picked up on its own accord. Yes, rising unemployment is not an encouraging backdrop for a growing demand for housing. However, housing has become increasingly ‘affordable’ with some estimates that ‘house prices to earnings’ could be running 15% below long-run averages. The only reason for suspecting that the scheme has had a measurable impact is that house builders are actively lobbying to have the scheme extended beyond its scheduled end of December 1st, the credit increased to a maximum of $15,000 and eligibility widened to any prospective buyer.
To be fair, government actions can often work by helping consumer confidence recover. The harsh reality though, is that so far there is little evidence that the various schemes in the US and elsewhere have added much to final demand. Much of the spending would have taken place anyway, there will have been ‘crowding out’ of other major purchases and, to a large extent, all that’s happened has been demand now rather than in the future.
Douglas Roberts, Senior International Economist, Standard Life Investments
This article was first published in Fund Strategy on 9th November 2009.
