Cash for Clunkers: Real stimulus

The boost to auto sales caused by the government trade-in program should lead to increased production from Detroit. That could have a big ripple effect.

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By Chris Isidore, CNNMoney.com senior writer

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NEW YORK (CNNMoney.com) -- Can the end of the recession be found in a scrapped clunker?

It's not that simple, of course. But many economists agree that the popular Cash for Clunkers program is likely to provide a significant lift to more than just the battered auto industry.

"History shows that the success of stimulus packages depends on people responding to the incentives to spend money," said Joseph Carson, chief economist at AllianceBernstein. "It's having an intended, if not larger, impact than people expected."

Carson said the $1 billion in government money spent on Cash for Clunkers program has unlocked private spending. The maximum payment of up to $4,500 for turning in an old car only provided a fraction of the cost of a new one. So people either dipped into savings or arranged financing to buy cars.

The Senate is widely expected to pass a $2 billion expansion of Cash for Clunkers Thursday. The House did so last week after reports that the original funding earmarked for the program was set to soon run out. And according to some estimates, the total of $3 billion spent on Cash for Clunkers could result in an $18 billion boost to the overall economy.

"In terms of bang for the buck, this is up there pretty high up there," said John Irons, research and policy director for the Economic Policy Institute, a liberal think tank.

David Wyss, chief economist for Standard & Poor's, estimates that the program could add about a half of a percentage point to gross domestic product, the broadest measure of the nation's economic activity, over the next two quarters. That's in line with the estimates from economists at General Motors, an obvious supporter of the program.

While that sounds small, Wyss said it's a significant impact for a program of such relatively modest cost to taxpayers.

Wyss said that Cash for Clunkers could lead to lower auto sales down the road because consumers are merely moving up purchases of cars to take advantage of the program. But he added that the short-term bump in sales and resulting increase in production from the program makes outweigh the costs of a future hit to sales.

"When you fill a pothole, you have to get the dirt from someplace else. But that doesn't mean it's not worth filling the pothole," he said. "The auto industry has been a pretty deep pothole on the U.S. economy."

Auto industry experts estimate that 750,000 clunkers will be scrapped as a result of the program -- assuming the extension is passed by the Senate as expected. So that should lead to sales of 750,000 new cars.

Executives at auto companies have conceded that about half of those vehicles probably would have been purchased even if the program were not on place.

Still, Mike DiGiovanni, GM's head of sales analysis, said that another 200,000 cars could be sold to buyers who aren't even participating in the program. That's because Cash for Clunkers has caused an increased boost in traffic to dealers.

Boost to production will have a chain reaction

Inventories for most automakers are now at record lows because of the sharp cutbacks in production earlier this year. So if Cash for Clunkers leads to even more interest in new cars, the auto industry will need to increase production by about 600,000 vehicles for the rest of the year to restock inventories. That's equal to about a three-month output of nine to ten auto assembly lines.

"It's going to stimulate production big time," said DiGiovanni. "Most of us don't have production to meet that demand in our current schedules. We'll be increasing production schedules in the third and fourth quarters. I'm sure everyone else is looking at that too."

Not all the increased vehicle production will happen in the United States. Some hot sellers under the program, such as the Toyota (TM) Prius or Hyundai Elantra, are being imported from Asia. Even some of the "domestic" hot sellers, such as the Ford (F, Fortune 500) Fusion, are built on Mexican assembly lines.

But many of the import models getting a lift in sales, such as the Honda (HMC) Civic and Toyota Camry, are built on U.S. assembly lines.

Increased production by the big automakers could have a sizeable ripple effect throughout the economy. The battered auto parts sector is getting a needed shot in the arm from the program. That's true even for the cars assembled in Mexico and Canada.

Dealerships, which have suffered widespread closures beyond those mandated by the bankruptcies of Chrysler and GM, are also getting a much-needed lift in sales and profits.

Of course, there are some critics of the program as well. Some argue that consumers who spend money on new vehicles will have less money to spend on other items, and that it doesn't do anything to add to economic activity and wealth.

"You're taking a very large sum, hundreds of dollars, out of a household's monthly cash flow to dedicate it to a new car loan," said Rich Yamarone, director of economic research at Argus Research. "You're stealing from the amount that can be spent on food, clothing, shelter, the essentials, as well as vacations and refrigerators and other big-ticket items."

But others argue that the cost of maintaining clunkers is also a drain on household budgets. Consumers are also likely to save more than $1,000 a year, depending on gas prices going forward. due to the improved fuel economy standards mandated by the program.

So that could mean that the impact of Cash for Clunkers could last even after the program eventually ends.

Talkback: Do you think Cash for Clunkers has been a success? Share your comments below. To top of page

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