Public Policy Courses and nuances!

[Trivia First – When you see tailless rats, then think about it– whether there is someone incentivizing to kill the rats to save the granaries, sanitation infra etc and people to produce the tail as proof of killing the rat rather started growing rats so that they can cut the tail multiple times. You can see multiple perverse incentives here.]

There is a good trend over the past couple of years in India as well as in rest of the World. We have adopted more heterodox approach to solve public policy issues. To support the rising demand for public policy practitioners, there are many private and govt. affiliated institutions come up with public policy courses in India. Even within social science, there is a move towards transdisciplinary approach. In economics too, there is greater acceptance of diversity away from neo-classical approach.

In a crisis time like this, what we need is more pluralistic approach to solve public policy issues. There are solutions which would appear obvious but what we need is to look at beyond the obvious. This note is written in that spirit.

One question which is in the headline across the globe is – is the stimulus enough to revive the economy? Do we need more fiscal stimulus? Yes, we do need more stimulus. However, how do you design a stimulus package so that it achieves the purpose, or it does not defeat the very purpose for which it exists.

If you are a student of public policy course, this is the time you may invest in reading through experiences of many public policy intervention that had happened around the globe and especially in crisis time. The ideal way is to look at – systematic reviews or meta-analysis. You may not find many. In that case, you can look at various studies that would have come up on the same issue so that you are adequately aware about various dimensions.

One such crisis time intervention that USA govt. did in 2009 is the – ‘Cash for Clunkers’ (CfC) Program or more correctly CARS (Consumer Assistance to Recycle and Save) program.

During the global financial crisis, when the Auto sector in US was in a bad shape, US govt. gave vouchers to trade in old less fuel-efficient vehicle against purchase of new fuel-efficient vehicle. Apparently, it gave boost to the economy as well as to the auto sector.

However, after 8 years, in 2017, there are three Professors from USA (two from Texas A&M University and one from University of California, Santacruz) published a paper in American Economic Journal: Applied Economics with a title  - ‘Cash for Corollas: When Stimulus Reduces Spending’[1]. One of their key finding based on quasi-experimental evaluation method using Regression Discontinuity Design (RDD) as identification strategy is that – ‘the $3 billion program reduced total new vehicle spending by $5 billion’.

Ah! How can it be? Why? How come a policy that is designed to boost the sales of auto sector had a result opposite to what was expected?

Well, if you simply plot the data, you won’t see it. You will see the intervention led to better outcome.

To see it, you need to wear a lens of a researcher with a counterfactual mindset. Here comes your public policy training as well all those methods (Diff-in-diff, PSM, RDD, IV method etc) you would have studied to do a counterfactual analysis i.e., the potential outcomes framework. In case your college offers a public policy program without an element of these, you should demand at least two papers – Experimental methods, Quasi-experimental methods.

When you design something – think through how it might playout from various perspectives. What is going to happen without this intervention? Will this intervention create some adverse incentives? Will it promote moral hazard? Ask yourself as many questions as possible and see through the evidence that already exists. Be skeptical in the beginning unless you are proven wrong by evidence – be it theoretical construct or empirical evidences.

While this paper (Cash for Corolla) may not be conclusive or even if the future research shows evidences otherwise, what it certainly does is to push you think hard – how do we design public policy so that we do not get into the trap of unintended consequences? 

The story goes like this!

Eleven years ago (24th June 2009), US govt. enacted a legislation known as CARS (Consumer Assistance to Recycle and Save (CARS) Act. This program is popularly known as – Cash for Clunkers. It had two purposes –

1.       Revive the US auto industry through boosting new car sales and scrapping the old vehicles;

2.      Nudging people towards being environmentally more sensitive by purchasing fuel efficient vehicles.

US Auto industry was struggling with falling sales – a seasonally adjusted sales fall of 16 million in 2007 to 10 million in 2009. Auto industry provides large employment directly as well as in the value chain. Revival of Auto industry would mean that households would have higher purchasing power which in turn they would spend in consuming other goods and services. It would kick-start a chain reaction helping in the speedy recovery of the economy. The idea was brilliant.

The truncated eligibility norms goes like this - If you have a vehicle of less than 25 years of old and mileage per gallon of 18 or fewer, then you can get a cash voucher in various slabs – varying between USD 3,500 to 4,500 depending upon the difference between the new vehicle MPG and trade in vehicle mpg. For example – if the new car has 22 mpg and the difference of MPG between new and old is 4-9 mpg, then you will get USD 3,500 and if the difference is more, then you will receive USD 4,500. For exact act and eligibility, you can refer to the original act. This is just a broad summary of the intervention.

Initially govt. had allocated USD 1 billion with the intention that the program would run from July 1 and November 1, 2009. However, within 30 days, USD 1 billion got over and govt. had further allocated USD 2 billion. Even the additional allocation got over by 24th of August 2009. It was a huge success. In fact, the auto sales spiked (fig 1).

Gayer and Parker (2013) gives nice chart and tables to show how the program benefitted people as well as evidence from other studies highlighting the downside of the program. However, there are many studies which are not that sanguine about the positive effects. You may look at Mian and Sufi (2012), Li, Linn, and Spiller (2013) and Copeland and Kahn (2013). These studies show that the net purchase effect of the stimulus is much smaller. People who have purchased the vehicle under the program are in any case would have bought the vehicles even in the absence of the program.

Let’s just look at the recent study by Hoekstra, Puller, West (2017) - ‘Cash for Corollas: When Stimulus Reduces Spending’. They are the first one to use quasi-experimental technique (RDD) to examine the impact of CfC on overall new vehicle spending.

Their key findings are as follows (taken directly from the paper with a little/no edit):

1.       CfC (Cash for Clunkers)—which dispensed $3 billion in subsidies toward the purchase of 677,000 new vehicles nationally—reduced revenues to the auto industry by more than $5 billion over the course of less than one year.

2.      CfC significantly increased new car purchases during the two months of the program. However, the increase was modest relative to the size of the program, as nearly 60 percent of the households who purchased under the program would have bought a new vehicle during those two months anyway.

3.      The subsidized purchases were merely pulled forward from the future (which were roughly 45 percent of all purchases) were accelerated by a maximum of 8 months. The program did not result in any more vehicle purchases than otherwise would have occurred over the ten-month period that includes the two program months.

4.      The program performed poorly in achieving its secondary objective of improving the fuel economy of the US fleet. The program induced households to purchase vehicles that were only three MPG more fuel efficient than the vehicles they otherwise would have purchased…Each subsidy generated only $253 in environmental benefits compared to an average taxpayer cost of $4,210 per subsidy.

Now let’s ask this question -

Why didn’t the program achieve the desired outcomes (as per the researchers while the policy architect would say it was a great success)?

The paper says that – “conflicting policy objective can cause a stimulus program to instead have a contractionary net effect on the targeted industry”.

What are the conflicting objectives – boosting auto sales along with the environmental goals. If the objective during the crisis was to pump prime the economy, the environmental dimension by way of bringing the MPG criteria should not have been there in the first place. If you try to achieve both at the same time, there would be a trade-off.

The paper says – “The program’s fuel efficiency restrictions could have shifted both the type and price of vehicles purchased, which would have important implications for the program’s effect on automobile industry revenues.” Also, the paper estimated that – “…. each household purchasing under the program spent an average of around $8,000 less on a new vehicle than they otherwise would have.”

Why? The paper noted that –

“In 2009, manufacturers offered hybrid versions of several models with prices about $5,000 higher than the standard versions. However, these examples are more the exception than the rule. The general trend is that higher fuel economy vehicles have lower prices. This relationship … shows a negative overall relationship between MPG and vehicle price among the set of vehicles offered to US consumers. Therefore, a second possibility is that consumers could respond to the fuel economy restrictions by purchasing smaller, less expensive vehicles. In fact, the most popular new car purchased under the program was the relatively inexpensive Toyota Corolla.”

That is the unintended consequences of the program!

Therefore, when you are helping in the design of a public policy or for that matter policy for companies with wider impact on various stakeholders – think through it in multiple layers and through multiple lenses. Think through the ripple effects it would create once it comes to play. Your public policy course – especially your course on impact evaluation would come handy to think through these issues.

[1] Mark Hoekstra & Steven L. Puller & Jeremy West, 2017. "Cash for Corollas: When Stimulus Reduces Spending," American Economic Journal: Applied Economics, American Economic Association, vol. 9(3), pages 1-35, July. Originally it was published as NBER Working Paper No. 20349 in 2015.