Sunday, April 12, 2009

Wealth Destruction and Government Policy

I had not planned to post again so soon after publishing two articles in quick succession, but a recent article has been nagging away at me for the last couple of days. The article comes from The Times, and deals with a proposal to pay for the scrapping of cars:
It has been on and off for months, but a key announcement in Alistair Darling’s budget in 10 days’ time looks like being a car “scrappage” scheme. The motor industry is in trouble and thinks the best way to reverse an alarming slide in sales is to give people who trade in old cars for new or nearly-new ones a £2,000 allowance.
At the moment, this is still not UK policy. However, as the same article points out, this is not a completely new policy, as it has already been enacted in other countries:
Eight European Union countries – Austria, France, Germany, Greece, Italy, Spain, Portugal and Romania – have introduced scrappage schemes. The biggest impact has been in Germany, where sales last month were up 40% on a year ago, leading the government to treble its funding for the scheme. In France, with a smaller incentive, sales were up by 8%.
As can be seen here, the way in which the scheme is presented is to suggest that this is good and much needed policy. The article does include some critiques of the policy; that it is not 'green' and that the resultant sales of new cars will not necessarily stimulate the domestic manufacturers. To these obvious problems, it might be added (subject to the detailed final plan) that it will simply create a market in second hand cars to be sold for scrap in the scheme. i.e. cars that would be scrapped anyway will be sold to purchasers of new cars in order for them to qualify for the subsidy.

However, this is not the fundamental flaw with this plan, and no commentary that I have seen does deal with the underlying problem with this idea. This is the problem of what the the plan is doing in principle.

In particular, the principle is the wilful destruction of wealth in order to generate economic activity. Each car that is build represents the utilisation of labour, materials and capital to build the product, and the end product represents a store of that wealth. Whilst the value of a car declines, for every year of its life it still represents a store of the wealth that was created. When a person scraps a car before its 'natural' end of life, they are actively engaging in the destruction of wealth.

At the extreme, this is the equivalent of bombing a city to create activity, but without the drama and the inherent sense of absurdity that this represents. On the same principle, we might see a proposal to purchase toasters to scrap them, or the purchase of beef in order to throw it into landfill. Why not knock down some buildings, rebuild them, knock them down again, then rebuild them again? Why not scrap some bridges coming to the end of their life and rebuild them, as the construction industry need help too. The potential for destruction to create 'activity' is limitless, and might be applied to just about anything.

In all of these cases, there would be a destruction of wealth, and the economy would be 'stimulated'. The difference here, with the idea of scrapping cars, is that they are 'used', such that the principle of what is actually being done is not so evident. If the government were, for example, to purchase toasters and scrap them, there would be an outcry, but the underlying principle is identical to the scrapping of used cars.

As if the wanton encouragement of destruction were not absurd enough, this process is being undertaken with borrowed money. The government is therefore proposing borrowing money in order to destroy wealth. What that means is that, at some point in the future, £ 'x' million will no longer be available to, for example, build a hospital or pay for a school teacher. Alternatively, more taxes will need to be raised to repay the borrowing, meaning that you will have £ 'x' less to buy yourself a new car. It is perhaps in this latter example that we can best see the absurdity of the situation. Your future ability to purchase a new car will be diminished because the government is borrowing money to destroy the wealth that is inherently retained in another person's car.

A few months ago, I highlighted an article in the Economist magazine in which they discussed how Hurricane Katrina would create an uptick in GDP. In the post, I highlighted how the massive destruction of stored wealth represented by Katrina could be seen by Economists as a 'good thing', and how absurd such a notion was. However, this was the destruction of wealth through natural disaster, so perhaps might be excused on the basis of trying to look on the positive side of a bad situation. In the case of car scrapping it is an act of destruction devised and enacted by government.

If ever there were an indication of the absolute bankruptcy of ideas to fight the economic crisis, an indication of the underlying idiocy of government policy, then surely this is it. They are acting to destroy wealth to 'save the economy', and doing so at the expense of the future economy. They are spending future wealth in order to destroy present wealth.

Quite simply, the mind boggles.


  1. Why not have perpetual war, the ultimate scrappage economic driver.

    Eh, hang on, isn't that what America is doing?

  2. Mark, I totally agree, and the idea of this scheme makes me quite angry.

    However, doesn't free market capitalism aim to do the same thing, too? 'Consumers' are under perpetual pressure to scrap perfectly good items and buy marginally shinier/smaller/bigger/faster/'greener' replacements. The difference here is that it is the state encouraging it, rather than the usual sophisticated marketing and advertising operation.

  3. For the life of me I cannot see us returning to mindless consumerism which scrappage inscentivism is all about. As for the green credentials of scrappage the mind positively boggles.

    The MSM still refuse to use the 'D' word and yet the more astute commentators out there are at a loss to see where the exit of this mess is. They are saying it is still unfolding and the end isn't in sight yet.

    It's strange that the green shoots brigade are the same people who didn't see it coming in the first place.

    Cynicus, maybe you take an overview once in a while as where this thing is taking us.

    Can you see 'when it is over'? .....things will be....

  4. I too read the Times article with increasing anger at our government's endless stupidity.

    I was struck by the way your analysis incidentally throws a light on the enormous destruction of wealth that has been concealed within the UK housing boom. You wrote: 'Why not knock down some buildings, rebuild them, knock them down again, then rebuild them again? ...there would be a destruction of wealth, and the economy would be 'stimulated' ...As if the wanton encouragement of destruction were not absurd enough, this process is being undertaken with borrowed money.

    This is comes very close to describing the way Lemming's comment has played out in the housing market over the last decade or so. Many individuals have been destroying and replacing perfectly good kitchens, bathrooms, furniture, soft furnishings, driveways etc. Property speculators have been doing exactly what you decscribe bar the fact that the new buildings differ from the old.

  5. Ah, the good old "broken window fallacy".

    However, let me play the devil's advocate for a minute. Since I'm online, since about 1997, I've see at least 500 articles, forum threads, blog posts and comments about the broken window fallacy. It's something impossible to avoid, you run into it in every corner of the internet, from reddit to cato to mises etc. etc. And it's such an old idea, first invented by Bastiat about 160 years ago, popularized in Hazlitt's very-very famous and influential "economics in one lesson", that I plain simply don't believe that the economic advisors of politicans have not heard of the broken window fallacy. the chance of that is zero. they must have heard of it.

    So. one option is that they plain simply don't care - they want to things that look cool and popular and that's all.

    other option is - and here comes the devil's advocate in - that maybe the broken window fallacy is too theoretical and perhaps sometimes it's not a fallacy in practice. I don't really how or why could it happen, but maybe it does. for example the whole thing can just be the smoothening of demand in time: those cars would be scrapped in a year anyway, the state incentives it to happen earlier, to bring demand earlier in time, because in a deep recession perhaps demand is more important than it will be later on? something like that?

  6. All this is entirely true if we just look at the pure material value of things and nothing else. But people, and society, are more than just numbers.

    The government position presumes that recovery will come soon. They believe if they can throw a lifeline to the car industry they can keep jobs and industry alive until a better sun shines.

    If recovery really was imminent, I think I'd support the idea (briefly). Because people are more than just numbers. Industry, once gone, would be unlikely to return due to the investment involved in building new factories and the cheaper places in the world they could be built.

    I think that workers in the car industry having the job they know and love has a value too. As does the security of a job in these tough times.

    While I follow your argument and enjoy it, I do feel there is a place for these sort of schemes in the right circumstances. These are just not the right circumstances.

  7. If the government could require that the discount on new cars was only for cars manufactured in the UK. But alas thats pie in the sky. So this subsidy on new cars will help european and far east car companies and their jobs much more than the UK's.
    I think there is more benefit to this policy than you might think. The value lost by scrapping a 10 year old car is not very much. Afer all its given 10 good years of service and value. And the opportunity cost of keeping a going concern running through lean times has to be considered.
    Still there is no way I'd be so stupid as to go out and by a new car , especially in these times. I'm waiting to use my cash to put into appreciating assets not depreciating ones.

  8. Another great article Mark. Found this from shadowstats which you/your readers may find interesting

  9. Lemming I believe you are correct and this seems to expose a real flaw and contradiction in CE's analysis his earlier stated belief that there is no basic problem in economic growth, and no real problem in a system built around consumption. The benefit of capitalism is the provision of goods and services to meet the needs and wants of individuals, and it has consistently delivered on that promise, and provided the many innovations that arise from such a system that benefit us in a myriad of ways.

    I think if you want to deal honestly with this point we have to look at some of the arguments that capitalism must create false desires as part of its process. I think now most people could believe that our economic system must create needs and desires that previously did not exist to sustain growth.(Did US banks create/exploit a need for sub-prime mortgages or are they victims of deadbeats?). If we accept the benefits we must also accept the harm it does. This can be a profoundly unhealthy process, take pornography/fast food as examples, which have boomed to become a huge industries to meet false needs that have mutated and become tacked on to human biological processes.

    While all very rational no doubt in terms of market forces etc. to me they seems to do more harm than good to those that consume it and may even give rise to new industries that exploit the fall-out (sex-addiction counsellors, gym memberships etc).

    We don't need to be Marxists to see that he was correct one one point: that booms and busts / creative destruction are NECESSARY to the survival of capitalism. Perhaps A. Darling is merely acknowledging 'Schumpeter's Gale' == > "the process of industrial mutation .. incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one ... [The process] must be seen in its role in the perennial gale of creative destruction; it cannot be understood on the hypothesis that there is a perennial lull." (from "The Process of Creative Destruction" by Joseph A. Schumpeter, 1942). If a few hundred million jobs are lost here and there, we cannot complain if we truly believe in market forces and the market has decided it no longer needs most of us and our daughters must become lap-dancers or whatever.

    (I wrote this very fast so if there are logical non sequiturs etc don't be too harsh. )

  10. Mark,

    Reminds me of the old joke when a man is told by his doctor that he has lung cancer, and the operation will cost him $100,000. When he said that he cannot possibly afford it, the doctor told him that for $1,000 he can get the X-rays retouched...

    That's pretty much the situation we find ourselves in. Politicians (in our part of the world) simply do not look at fundamentals, nor do they care about what happens in 5 or 10 years time. All they care about is getting some positive statistics in the short term, so their chances of reelection improve. Arguments about the "broken windows fallacy" simply do not figure in their calculus. This insane short-termism is also responsible for the collapse of our "real" wealth-producing capacity. For decades, CEOs have been incentivised to asset-strip, offsource, offshore, scale-down anything which may make next quarter's numbers look better, regardless of long term consequences, not only for the country but also their company. From their point of view, these actions are quite rational. A CEO, who can make the quarterly numbers look good for a few years, will amass enough (real, tangible) personal wealth to enable him and several generations of his descendants to live in comfort, even if all hell breaks loose and they will never be able to work again. In Soviet times, the five-year plan for porcelain factories was expressed in tonnes of finished product. So what did a savvy porcelain-factory manager switch his production to in order to maximize his chances of meeting the plan goals? Was it china cups and saucers? Nope! It was -- toilet bowls! (There was never a shortage of toilet bowls in Soviet Russia). People tend to behave rationally in the context of their incentives.

    We are starting to pay for the follies of the way our system evolved. Unless there is some mass re-awakening to the reality, we are in deep doo-doo...

    Great analysis B.T.W. Hopefully others will start thinking for themselves.

  11. I agree both with your post and with Lemming's comment. The whole system is being run to create activity not to maximise ordinary people's well-being or even wealth.

  12. Worse still, by taking out of circulation good second hand cars, it will increase the price of the second hand car market making it less affordable for the majority to purchase cars.

  13. Fool of a government.............. now all new cars will increase in price by £2000.

  14. George Monbiot beat you to it:

  15. Anonymous: Yes, war is a great stimulus to 'activity'. As for wealth creation is the ultimate machine of consumption and wealth destruction. However, some economists might see the massive output and consumption and think this a good thing...

    Anonymous: I would love to see where the crisis is taking us. However, as each week goes by, ever more government intervention is piled on top of more government intervention. There is an interesting article in the Times on this subject, which points out that economics has become political economy....

    The economy is increasingly in the hands of government, and their actions are becoming ever more desperate. As such, it is difficult to see where this will end, except to say that it will not be a happy ending.

    Lemming, ChasH and 'Me' (Me is a commentator's pen name):

    Lemming, you make a very interesting point. You are right to point out that individuals do the equivalent of scrapping cars every day.

    A later commentator (Called 'Me) takes up this point and suggests that this is a flaw in my earlier analysis.

    However, I will explain it this way. Your neighbours decides that they are going to redecorate their living room. They come around to your house, knock on your door, and ask for you to help pay for the decoration. What will your answer be?

    The government is doing something similar to the case of your neighbour. How the neighbour spends their own money on consumption is their concern. How you spend your money on consumption is your concern. In the case of the scrappage plan, you are doing the equivalent of paying in part for your neighbour to redecorate their home.

    Whilst government might have a role in society, subsidising one person's consumption by borrowing money on your behalf to destroy wealth, and later demanding payment from you, is not really the same as you destroying your own wealth.

    In fact, under the way this scrappage plan is being sold, using the same principles, there is no reason why a subsidy for home redecoration might not be implemented. After all, the DIY industry is suffering, so why not offer home redecoration subsidies?

    You could even increase activity by hiring inspectors to check that the house is in need of redecoration. For example, they might check whether the colour scheme is out of fashion, and authorise a subsidy to update the colour scheme.

    The possibilities for this kind of lunacy are simply endless.....

    For the commentator called 'Me', you may note that I have pointed out (in the post you refer to) that the government has structured a system that encourages debt driven consumption. I am against this, and suggested ways to rebalance towards saving.

    However, the key point that I emphasised was the underlying moralistic dimension to much of the anti-consumption rhetoric. You say the following:

    "This can be a profoundly unhealthy process, take pornography/fast food as examples, which have boomed to become a huge industries to meet false needs that have mutated and become tacked on to human biological processes."

    Taking the less controversial example of fast food that you cite here, you are talking about the health implications. Do you smoke, or drink, ride a motorbike, or play any dangerous sports? Ever been mountain climbing or absailing, or even horse horse riding? Ever been scuba diving? I could go on. All of these are tacked on to a desire for excitement in some individuals.

    Would you ban all the horse riders from their activity? This is a shockingly dangerous sport - and they even encourage children into it! Ban it now! Look at the terrible price in death and injury!

    There are many dangerous activities that people indulge in. It is their choice to do so, but in some cases (e.g. eating fast food) there is moral outrage. I would ask you why it is that we admire a mountain climber who risks their life 'pointlessly' climbing Everest at risk to their life, but pour contempt upon a person for eating a hamburger?

    What of arctic explorers coming back from a trip minus a couple of fingers. What is their health risk compared with a person eating a hamburger?

    As I said in the original article, there is a moralistic undertone to the anti-consumption discussions. If you think that eating a burger is a health hazard, then there is a need for consistency. All activity dangerous to health, and undertaken for pleasure, would need to be reviewed. Where would you draw the line of acceptable risk?

    The simple point here is this. Both eating too many hamburgers and climbing mountains are dangerous to health, and both give the individuals who indulge in them some pleasure. Some people set themselves up as judges of which is a 'good' activity, and which is 'bad'. I do not believe that I, or anyone else, should be the one to encourage or ban either activity.

    I ask the question of where to draw the line, because there is no rational or consistent way of drawing such a line. One way or another, a person will finally arbitrarily determine what is 'good' or 'bad' based upon a sense of moral righteousness. Woe betide you if you are on the wrong side of that line....

    A long answer, but I hope that it makes my point clearly.

    Miklos (and Howard): A good devil's advocacy, but how would you feel about a brand new toaster coming off a production line, and then being placed directly into a metal crusher? How would seeing, for example, 100,000 toasters being produced then crushed make you feel? Could you rationalise such action?

    The point about the car example is that it is the same effect, but somehow it feels better because the car is coming to the end of its life. However, the destruction of 100,000 used cars is a greater wealth destruction than the toasters in the example I have given.

    I hope that, when put in these terms, the complete absurdity of the action is clarified. There are other arguments that can be put forward, but I hope that this will suffice.

    Steve: I agree about the human dimension. However, what we now have in play, and what will always be the case, is a situation in which the state with the deepest pockets will win the game.

    Whoever can throw the biggest subsidy for the longest time gets to keep their car industry. In the meantime, each country will pour money into pointless activity for which there is no demand - making cars that nobody wants at the 'real' price.

    In fighting and competing this way, massive resources are being wasted that could be used in developing and supplying products that people want. Furthermore, in the end, you are not left with the most efficient car industry, but with the industry that has survived because the national government has the deepest pockets.

    Better that there are no subsidies, and that all subsidies are punished through trade restrictions/sanctions. The alternative is a world built upon mercantilism, and so far China is winning that mercantilist competition....Even if taking a nationalist perspective, it is not certain that countries like the UK might win such a competition.

    After all, the pockets of the UK government are already empty. They simply can not afford to subsidise any industry, as they do not have the resource to win the subsidy game...Perhaps this is the point that you are making when saying 'not the right circumstances'?

    Much more could be said on this subject, but this would need a full post. My central point is that mercantilism is a problem, and these subsidies are just one such example. Perhaps I have gone slightly off-track from your comment, but I hope not too far.

    Matt: An interesting article that you have linked to. The big question is when the overseas money will finally flee? I keep on thinking it must be 'now', but still the $US trundles on obliviously.

    MattinShanghai: A very evocative illustration of the impact of poor incentives.

    Anonymous 1&2: You are quite right that the price of second hand cars may well go up, and that this will hurt those who are not well off. A very good addition to the argument. With regards to the price of new cars going up, I am not sure that rather it will stop the price going down. However, the effect will be the same - people will end up paying more for cars than would otherwise be the case, though this will not be paid for by the purchaser, but by everybody else.

    Phil: I have taken a look at the article. Not quite the same perspective, but I find that I can actually agree with some points Monbiot makes. This is most unusual...

    I hope I have responded to all comments. Please accept my apologies if I have missed any. As a note, I am using 'mercantilism' very loosely for the sake of brevity.

    I have rushed these responses a little as I am going away for a few days. I hope that they make sense.

  16. Hi Mark. Just a thought on the distinction between private and public economic policy: is there an essential difference between free market economics and 'free market' democracy? i.e. the process of choosing who to vote for, based on perceived self-interest (or ideology), is similar to participating in the market place. Couldn't Adam Smith's ideas also extend to politics i.e. that the wisdom of the 'consumer' will, on average, produce the best outcome for all, even though he is usually making his choices based on self-interest? Seen in that light, then governments' interventions in the economy could be seen as just another aspect of the free markets...

  17. I think Kunstler has got it right, it is depletion of energy that is the bogie-man, and nobody has got a clue how to confront it. And that's why, (IMO) the World is in turmoil, not only economically but politically too.

    Do not rule out the NWO, the big boys are way ahead of the curve.

    Kunstler says,....."Half a year of cratered oil prices have decimated the oil industry and we're driving at 100-miles-an-hour straight off a cliff into a new kind of supply crisis".....

    ......"translation: peak oil is biting back now with a vengeance. Its peakness will look peakier and the yawning arc of depletion beyond will look steeper and pose a threat to every globalized and continental-scale enterprise in the known world."

  18. What people fail to realize is that there are massive overcapacities (due to credit-fuelled demand) in the world and they need to be shredded. Simple as that. We can artificially keep them on the payroll only for so long, the bill eventually has to be paid. Or printed.

    Recently I have become even a little gloomier as any currency devaluation comes with less purchasing power for foreign assets like natural ressources, should the Chinese RMB become the currency of choice we in the West will be playing second fiddle.
    As far as I am concerned the party is over, best to set uo yourself now in a way that you are fully prepared for the new economic order.

    Money does not care how it is spent, by whom it is spent, what for it is spent.

  19. Firstly scrap the car tax.
    Secondly if we are to spend our childrens money please spend it wisely.
    Some idears.
    Increase sea defences by 3 meters.
    Build new railways that can carry long hail trucks,to free up our trunk roads.
    Build new coal fired power stations.
    Invest in tideal power production.
    Build new trunk roads into areas like norfolk.
    Build more reservoirs.
    Could GOV please take note and stop wasteing our kids money.

  20. Here in Czech republic the scheme has been enacted also.
    The destruction of wealth to "generate wealth" has been going on for decades, but it was being done in more sophisticated ways - through marketing new,better,bigger products.We have come to realize and feel it only now because it has finally crystallized.The very principle on which market economy functions needs to be radically changed.We have come to such point where we have an abundance of everything(cars,houses,high tech gadgets etc.)but we have to keep going since this is the only way we can earn money to pay for the goods that are already in oversupply.So the logic dictates to destroy oversupply. The whole thing looks like we have created the garden of plenty for everyone(at least in the West)in terms of the real beef but we are poor because we do not have "money" to buy it.

  21. Steve and Howard,

    Scrappage doesn't save jobs or businesses. The money that is now spent on cars would otherwise have been spent on other things, produced by other workers and businesses. Or it would have been saved, helping to correct the imbalance in our economy between saving and borrowing, which so desperately needs to be corrected if we are to have the sustainable lending that is necessary for businesses to thrive. Or it might have been invested, helping to create new jobs.

    The scrappage scheme increases the likelihood that car-workers' jobs will survive and that other workers' jobs will be lost. And when we've destroyed all the nine-year-old cars, there's a fair chance that the car-workers' jobs will also be on the scrap-heap. There is no net gain, and the increased inefficiency imposed on the economy produces a net loss.

    This is predictable in theory, and we are seeing it play out in Germany, where other sectors are suffering terribly.

    The reality is that, thanks to the illusions created by the boom, we have more car-production capacity in the world than is justified by uninflated demand. Trying to prevent any of this capacity from being destroyed (or converted to other uses, if you want to think of it more positively) simply delays the necessary correction, and pushes the costs onto other people whose jobs might have been sustainable if they hadn't had to shoulder part of the costs of the scrappage scheme.

  22. Cynicus,

    First they came for the bloggers:

    Watch your back!

  23. ITS ALL OK! Brown is now going to give a £5000 subsidy for electric cars. Now I know this sounds even worse than £2000 but it really isn't. One thing which I know about Mr Brown is that he is full of gestures, empty gestures. Nothing will come of this scrappage scheme. It won't happen, its just more verbal masturbation by the incumbent Mr Brown. Lots of announcements, especially with Green connotations, and Brown thinks he has actually delivered on something. But as we all know it will come to nothing. So inadvertently The government will end up doing the right thing, Nothing at all!

  24. Cynicus:

    Great blog, very informative and interesting

    Have you seen the article by former chief economist to the IMF, Simon Johnson, in The Atlantic? It describes, from an informed insiders perspective, exactly how our current economic woes are directly related to the grip that our very own oligarchs have on the US and UK economies and particularly the politicians that nominally represent we, the people.

    It's extremely interesting given who is saying it, and his hypothesis certainly seems to fit the facts on the ground.

    What are your thoughts on that?


  25. cynicus and fellow readers

    yee might find this article interesting

    maybe we can get a comment from cynicus on this



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