German 'cash for clunkers' shows free market perils

BERLIN Thu Apr 9, 2009 10:22am BST

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BERLIN (Reuters) - The "invisible hand" of the free market has been replaced by a "heavy hand" of state intervention in Germany, which is spending a small fortune to stimulate growth but creating winners and losers throughout the economy.

The government's "cash-for-clunkers" programme that offers anyone who scraps an old car 2,500 euros (2,269 pounds) towards the purchase of a new one has sparked an unprecedented surge in demand, giving struggling carmakers a welcome crisis-defying boost.

But the incentive, which at 1.5 billion euros represents only a small slice of its 81-billion euro stimulus efforts, has inadvertently hit retailers, car repair shops, used-car dealers and sent scrap metal prices into a free fall.

Amid an unprecedented consumer feeding frenzy to secure their 2,500 euros before the 1.5-billion euro programme is exhausted, about a million car owners have applied for the incentive towards the cost of a new, fuel-efficient car.

The government promised to extend the programme that led to a 40-percent jump in new car sales in March. But it has not yet agreed on details. Some conservative politicians oppose extending the funding, complaining about its costs and expressing fears it will only worsen the hangover afterwards.

"When the state steps in to replace demand there is going to be a certain amount of 'collateral damage'," said Joerg Kraemer, chief economist at Commerzbank in Frankfurt.

But Norbert Walter, chief economist at Deutsche Bank, said the negative "side effects" were a small price to pay in light of the enormous economic perils Germany and the world are facing.

"The car incentives are working quickly and effectively," Walter said. "If it were up to me, I'd have extended the incentives to other durable goods such as refrigerators, ovens and boilers that could be replaced with new, efficient models."

WINNERS AND LOSERS

At first glance, the "Abwrackpraemie", as Germans call the 2,500 euros paid to anyone who junks cars that are at least nine years old, has been a huge success with car sales surging every month this year and some factories adding shifts to meet demand.

But, beyond the concerns that there will be a steep slump in car buying once the incentive ends, there are also complaints from those with less political clout than the carmakers whose business has suffered at the hands of the state "dirigisme".

The German government's car incentive intervention thus serves as a cautionary tale of all the winners and losers that could be produced by the countless billions of euros in state stimulus flowing into economies around the world.

"Every time the government steps in it leads to distortions, and there are some winners and some losers," said Juergen Michels, an economist at CitiGroup in London.

Michels said the turbulence in Germany created by what might have at first seemed to be a relatively innocuous stimulus programme offered a clear illustration of unintentional consequences that state intervention can have.

"It is probably right to have more public authority action like the car incentive but it has to be done in a measured way," Michels said. "That's why governments have to be very cautious. They're never in the best position to play the markets."

THE INVISIBLE HAND

Scottish economist Adam Smith coined the term "the invisible hand" in the 18th century to describe the positive effects of the free market on individuals.

Yet the worst economic downturn since the Great Depression has led governments around the world to re-evaluate that belief in the "invisible hand" and to prop up sagging economies.

Countries such as Japan, France, Italy, South Korea and others are considering or already have similar car incentive programmes. In Britain, radio listeners on Monday were lamenting the absence of such a "cash-for-clunkers" programme there.

But if they listen to some of the "losers" in Germany, they may have second thoughts.

Stefan Genth, the managing director of Germany's HDE retail association, sharply criticised the state subsidies for cars.

"Consumer funds that the state is channelling by the billions into the car market are being sucked out of other areas, primarily the retail sector," he said. "Consumers can best decide for themselves what they want to spend money on."

Retail sales in Germany plunged 5.3 percent on the year in February and the retailers association blamed the car incentive.

"What we're seeing is a redistribution of consumer spending to the detriment of the retailing sector," HDE spokesman Hubertus Pellengahr said.

Steffen Kampeter, a budget expert in Chancellor Angela Merkel's Christian Democrats, opposes extending the incentive.

"It should be obvious to everyone that makers of durable goods are suffering because of the car incentive," he said.

But it is also devastating the used car market. Prices for used cars have plunged, especially for cars in the 8,000 to 12,000 euro range that have almost instantly lost 30 percent of their value, according to German media reports. Angry used car dealers have begged the government to cap the incentives.

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