Wednesday, August 5, 2009

Cash for Clunkers: What Is Seen and What Is Not Seen

According to William James in his 1890 book, Principles of Psychology,
"[Attention] is the taking possession by the mind in clear and vivid
form, of one out of what seem several simultaneously possible objects
or trains of thought...It implies withdrawal from some things in order
to deal effectively with others." Since our minds our limited,
attention allows us to deal with the world effectively.

Well, somewhat effectively. In the realm of politics especially, the
vagaries of attention often mislead us. For example, Edward McCaffery
and Jonathan Baron find that people do not mind hidden taxes nearly as
much as transparent ones. Income tax withholding, by reducing the
salience of taxes paid on April 15, may make higher levels of taxation
tolerable to the public.
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Our cognitive limitations often debase political debate, making
politics a battle for voters' attention. Hence, the power of
soundbites and slogans, such as "Cash for clunkers." The way to make a
policy attractive is to hide the damage it does, and make its alleged
benefits salient. This point was made vividly by Frédéric Bastiat in
his 1848 essay "What is seen and what is not seen." He points out, for
example, that even a nutty policy like going from house to house
breaking windows can seem attractive as a way of providing employment
to glaziers. What is not seen is that the resources people spend
getting their windows repaired might otherwise have been devoted, for
example, to buying shoes. So even in the short run breaking windows is
not a stimulus, because it puts the cobbler out of work. And in the
long run, it reduces the total wealth of society.

As for cash for clunkers, one motivation for the policy is legitimate,
encouraging people to switch from high polluting cars to low polluting
ones--though the specifics of the program do not seem to achieve this
very efficiently. But the other motivation for the policy, that it
will stimulate the economy, is much like the proposal of breaking
windows to stimulate the glass-making industry. A similar objection
applies to wasteful spending in general, such as the economic stimulus

It could be argued that the auto industry needs stimulus more than the
many industries that will be harmed by higher taxes. This would be
based on the notion that in the long run domestic carmakers are due
for resurgence, so current industry cutbacks and job losses are
inefficient. In this story, government can help prevent the waste of
resources by cushioning the industry until domestic carmakers bounce
back. However, this assumes that the government is good at guessing
which industries should grow and which should decline.

Unfortunately, government is not well-positioned to make these calls
in a way that benefits society. Government incentives respond to
political pressures, not to market fundamentals. This makes government
especially responsive to entrenched parties, such as large, old,
inefficient, 'clunker' firms, at the expense of new innovators.
Overall, government policy in the U.S. auto industry is to pay cash to
keep clunker firms going as long as possible. This gives 'cash for
clunkers' a double meaning.

This is part of a general tendency, discussed by Raghu Rajan and Luigi
Zingales, for government to subsidize entrenched players and to
protect them by hampering new and innovative ones. Large firms, even
if inefficient, have resources to spend on political pressure, and a
base of employees and other stakeholders with interests in the
survival of the firm. Small innovators can't match that clout. And in
the limit, an innovative new industry that does not exist yet will
have no political clout at all. The public does not perceive the full
costs of these taxes and regulations, because it's hard to notice
innovations that have never occurred. This is the power of what is
seen over what is not seen.

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