Q&A: What is a scrappage subsidy and will it work in the UK?

A scrappage subsidy is a “pay-to-scrap” scheme where a government offers a financial incentive to car buyers if they scrap a car that has reached a specified age and in its place they are offered a payment towards the cost of a new vehicle. Germany and France both offer scrappage subsidies to consumers and there is a growing number of voices from inside the UK business community and motor vehicle industry clamouring for one to be launched in the UK. The Retail Motor Industry Federation and the Society of Motor Manufacturers and Traders (SMMT) are at the head of the queue lobbying for a scrappage scheme to be introduced as soon as possible.

Scrappage subsidies have certainly become more popular. Germany offers a Euro 2,500 payment for cars more than nine years old and France offers a Euro 1,000 payment. In the United States, a ‘‘Cash for clunkers’ bill is being introduced which offers up to £3600 for US consumers to buy new, more fuel-efficient vehicle assembled in the US and up to £5400 for 100mpg or more plug-in hybrids. Customers buying cars built outside of the country will only receive a maximum of £2900. And in Slovakia where there has been huge foreign direct investment into their fledgling motor industry, incentives worth Euro 1,000 to Euro 1,500 are available.

Arguments for a scrappage subsidy

1. It is a direct incentive for consumers to buy a new vehicle - a targeted subsidy rather than the (ineffective) cut in VAT announced in December 2008
2. Stimulating demand will help keep car plants open and producing vehicles at a time when the credit crunch and rising unemployment has caused a collapse in new vehicle demand and production
3. There are environmental benefits if consumers swap older for newer - more fuel efficiency vehicles that emit less c02 per km travelled
4. Crushing (and recycling) used cars reduces the risk of a sharp fall in second hand car prices caused by vast over-supply
5. Some of the financial costs of the subsidy would be recouped by the revenue from the VAT charged on new car purchases

Arguments against a scrappage subsidy

1. Distortion of market competition - why should the car industry be in receipt of a subsidy and other sectors miss out? If cars can be scrapped for a payment why not old televisions, or second hand books?
2. The payment brings forward demand that might have occurred anyway and risks a sharp fall-off when incentives end. Economists call this a deadweight loss - a benefit is being given to people who would (eventually) have bought a new car anyway
3. There are extra costs of crushing / disposing of vehicles that was still roadworthy and usable
4. There is an opportunity cost to financing a scrappage scheme - the money might be better spent developing greener public transport alternatives
5. Subsidies might be a catalyst for protectionism i.e. only giving subsidies for new vehicles produced within the domestic economy and not for importers. For example the Malaysian government finances 50% of their scrappage scheme, which pays owners of older vehicles to turn them in and purchase new cars from Malaysian produced Protons and Peroduas. In the UK, nearly 90 per cent of new cars are imported. UK made vehicles are exported to countries that may not have a similar pay to scrap scheme in place.
6. If the scheme is applied to the smaller most fuel efficient vehicles, only the Nissan Micra and the Mini would fit into the programme - they account for only 4% of cars sold in the UK.
7. We must also consider the C02 emissions created by the manufacturing of new cars

Consumers respond to incentives – usually!

The effectiveness of any scheme depends on the responsiveness of consumers to an incentive. Some estimates claim that a £2,000 subsidy might stimulate demand by as much as a quarter of a million year within twelve months, providing a major shot in the arm for a distressed UK vehicle manufacturing industry. But with motor credit increasingly difficult to come by and unemployment rising at a rapid rate, will there be sufficient consumer confidence for such a measure to work?

A scrappage scheme would be great news for recycling plants and car dealerships and perhaps just the fillip that our motor industry needs. But for many people such a scheme is an ill-disguised scheme for a failing industry that already suffers from over-capacity.

Handout article
What_is_a_scrappage_subsidy.doc

The Guardian has a special feature on the car scrappage issue here