Why scrappage schemes can’t save the global economy

Car scrappage schemes have been good to the Slovakian city of Žilina. As of July, the nearby Kia Motors plant was making 800 more cars a day than in December 2008, when Germany first announced it would give drivers €2,500 to scrap an old car and buy a new one.

Of Slovakia’s four biggest cities, Žilina is the only one where property prices held steady in the second quarter.

But if the immediate results of scrappage schemes have been favourable, the ultimate one, as the 19th century French economist Frédéric Bastiat might have put it, could prove fatal. And not just for property buyers in Žilina.

By offering consumers money to turn in their old cars for new ones, European governments have dragged spending forward. But history suggests that this brief sugar rush won’t be sustained. Following the terrorist attacks of 11 September 2001, US car firms unveiled 0% car loans to jump start sales. Sales duly rocketed in the next month, from 16.1m on an annualised basis to 21m. But a few months later, they were back at 16m.

And things are worse this time around. With incomes falling and unemployment still rising across Europe and the UK, consumers will not be in any sort of position to take up the slack once the car sales subsidies peter out.

Moreover, while the intention was partly to support local manufacturers, much of the scrappage subsidies have ‘leaked abroad’ to factories in countries such as Slovakia, which builds over 500,000 cars a year. Only 53% of cars bought in Germany in April were made there, says Capital Economics.

So Lord Mandelson’s decision yesterday to extend our own car scrappage scheme (see today’s Money Morning – The car scrappage scheme will cost us all in the long run – for more on this) may have been music to the ears of estate agents in Žilina. But “obvious solutions” as Bastiat could have told Mandelson, also have “unseen” affects. The biggest is that sales today come at the expense of sales tomorrow. And that means Žilina – like the car industry – is only being set up for a bigger fall in the months to come.