The New Auto Fuel-Efficiency Standards — Going Beyond the Headlines

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On My 19th, 2009, President Obama announced new Federal fuel-efficiency standards for motor-vehicles that would make the current standards — known as Corporate Average Fuel Economy — or CAFE — standards significantly more stringent. These CAFE standards measure compliance as the average of a company’s entire fleet of cars, and so are more flexible and less costly than model-by-model standards, better matching consumer preferences and lowering production costs.

Other good news is that the administration’s proposal will yield a single standard nationwide, rather than two fuel efficiency standards, one for California and the 13 other states that chose to follow its more stringent Pavley standards, and another standard for the rest of the country under the existing CAFE program.  The result would have been that the states adopting the more stringent California standard would have brought about little incremental benefit for the environment beyond the national CAFE program, because auto manufacturers and importers would have largely undone the effects of the more stringent state-level fuel-efficiency requirements by selling more of the less fuel-efficient models in their fleets in the non-Pavley states.  This has been validated in an interesting research paper by Lawrence Goulder (Stanford University), Mark Jacobsen (University of California, San Diego), and Arthur van Benthem (Stanford University).  Thus, dual standards would have increased costs, but with little or no additional benefit to the environment.

These new Federal standards proposed by the Obama administration can therefore be one small step along the path to meaningful reductions in greenhouse gas emissions that cause climate change. That’s the good news. But it’s also true that the new standards are inferior to other possible approaches.

First of all, CAFE affects only the cars we buy, not how much we drive them, and so CAFE standards are less cost-effective than gasoline prices at reducing gasoline consumption, because gas prices (whether reflecting market conditions or government taxes) affect both which cars we buy and our choices about driving.

Some people may think that CAFE standards — unlike gas taxes — are costless for consumers. But according to the administration, the increases in CAFE standards (including both scheduled increases already on the books and the new Obama proposal) will add — on average — $1,300 to the cost of producing a new car.

Because CAFE standards increase the price of new cars, the standards have the unintentional effect of keeping older — dirtier and less fuel-efficient — cars on the road longer.  This counterproductive effect is typical of any vintage-differentiated-regulation, a topic which I have addressed in a previous post.  There is abundant empirical research on this issue.

Also, by decreasing the cost per mile of driving, CAFE standards — like any energy-efficiency technology standard — exhibit a “rebound effect,” namely, people have an incentive to drive more, not less, thereby lessening the anticipated reduction in gasoline usage.  This has also been documented empirically.

The bottom line is that gasoline prices are a much more effective – and more cost-effective – means of cutting gasoline demand, both in the short term and the long term. But if increasing gasoline prices through gas taxes is politically impossible – which certainly appears to be the case in the current political climate – why raise all of these objections? Am I allowing the (infeasible) perfect to be the enemy of the good? Not at all, as I will explain.

There is, in fact, another policy instrument available that has the same desirable impacts as gas taxes on gasoline prices (and, more importantly, on all other fossil fuel prices, as well), but inspires dramatically less political opposition.  And this instrument is not only politically feasible, but is right now achieving remarkable, broad-based political support in Washington. I’m talking about the economy-wide CO2 cap-and-trade system in Congressmen Waxman and Markey’s legislation in the House of Representatives. Their cap-and-trade system will serve to increase the price of gasoline, cut demand, and reduce emissions.  But, in addition, its impacts will go far beyond automobiles and trucks, and beyond the transportation sector, as well.

To seriously and cost-effectively address climate change, it is essential to put in place a single carbon price that affects all fossil fuels and all uses throughout the economy — not only in the transportation sector, but also electric power, and the manufacturing, commercial, and residential sectors. This is precisely what cap-and-trade does.  A meaningful, upstream, economy-wide cap-and-trade system will serve to increase the price of gasoline, as well as other fuels, electricity, and all goods and services in proportion to their carbon-intensity in production, and it does this (as would a carbon tax) in the right proportions for each fuel, energy source, and product, so that the overall cap is achieved at the least possible cost.  The real bottom line is that cap-and-trade is the cheapest, best, and only politically feasible approach that can achieve the significant reductions in CO2 emissions that will be necessary to meet President Obama’s ambitious climate goals.

Back to the Obama administration’s CAFE proposal, a separate and distinct question is what will the effects be on the U.S. automobile industry?  Will this be “good for the auto industry,” as the White House press release claimed?  Doesn’t the presence of so many leading auto executives on the podium with the President clearly indicate that this regulatory change is good for the U.S. auto industry?

First, it is surely the case that a single national standard is better for the auto industry – and society more broadly – than the dual system that would have been brought about by the 14 Pavley states going forward with more stringent standards.  There’s nothing new about the U.S. auto industry wanting a single national standard.  Indeed, for this reason, the industry supported the enactment of Federal clean air legislation in the 1970s.  We all prefer bad news to worse news, but that does not mean we welcome the bad news or that’s it good for us.

It’s also true that the U.S. auto industry has vastly less political clout now than it has had in decades, plus a much smaller share of the U.S. automobile market.  The industry is in severe economic decline, indeed on the verge of bankruptcy, and it is depending now on massive government handouts.  In this climate, it is hardly surprising that the U.S. auto industry is being exceptionally cooperative with the Federal government.

But is this policy in the long-term interest of the U.S. auto industry; is this “good for the U.S. auto industry?”  The answer to that question is unknown.  Keep in mind that for decades the U.S. auto manufacturers have just barely complied with CAFE standards each year, while Japanese manufacturers and importers have exceeded the standards.  So, at first blush, it would appear that it may be easier — less costly — for Japanese companies than U.S. companies to meet the heightened fuel-efficiency standards.  I’m not saying that the new standards will put the U.S. companies out of business, but simply that we don’t know at this point what the long-term impacts will be.  In my view, one should be skeptical about claims to the contrary.  As I’ve suggested in previous posts, the best reason to carry out environmental policies is that they are expected to be good for the environment.

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16 Responses to The New Auto Fuel-Efficiency Standards — Going Beyond the Headlines

  1. Torben says:

    Cap and trade makes a good sense at least in the context of political feasibility. However, I am not sure whether it is technically feasible for the transport sector.

  2. Yes, of course it’s technically feasible. The appropriate point of regulation for a CO2 cap-and-trade scheme is upstream for coal, petroleum, and natural gas. This is carbon rights trading, not emissions trading. See my Hamilton Project paper, for example.

    RS

  3. No doubt cap and trade could reduce highway fuel consumption at least a little bit, but we need to know how much and at what cost.

    A gallon of gasoline contains about 5.5 pounds of carbon and yields about 20 pounds of CO2-equivalent emissions. If CO2 emission rights (whether via tax or cap/trade) cost $100 per ton, which is on the high end of what people are saying might result from the pending legislation, that would increase the price of gasoline by only $1.00. What impacts do you calculate that price increase would have on vehicle miles traveled and on consumer preferences for fuel efficiency of their new car purchases?

    FYI, the CBO calculated last October that gasoline prices might have to rise above $6.50 per gallon “for the average fuel economy of new vehicles in the United States to approach the 35 mpg that the new CAFE standards will require.” http://www.cbo.gov/ftpdocs/98xx/doc9830/10-06-ClimateChange_Brief.pdf

  4. Roger,

    Thanks for your comment. However, your CBO quote is an argument, in my view, against the CAFE standards. If the purpose is to reduce CO2 emissions and one wants to do it cost-effectively, then that means the same carbon penalty (shadow price) on all fuels, energy, and embodied-energy products. Yes, much more action in the short term would come from electricity sector and a few others in the short term; that’s what is cost-effective. Your response may be that there are other externalities — besides CO2 — associated with automobile use (such as congestion, insurance issues, other pollutants), but virtually all are associated with vehicle use, i.e. miles driven, not simply the technology. So those argue for additional fuel taxes, not for CAFE.

    RS

  5. This seems like a good place to repeat the old saying that “you can’t beat something with nothing.” The CAFÉ program is something: It’s specific enough that one can quantify costs and benefits. In that sense, the Stavins proposal is nothing: One can’t quantify anything—one just has to have faith that after all the ugly details are worked out, it will be more “efficient.” (While economic “efficiency” is always relevant, I don’t accept that it is the sole and ultimate measure of the quality of every policy.) After the following brief micro and macro pictures, I’m left with no evidence, data, analysis, or reason to think the undefined Stavins proposal is superior to the concrete CAFÉ proposal.

    Micro level

    The Administration has said the incremental capital cost will be fully recovered by fuel cost savings. Let’s see if that’s plausible. Assume that under CAFÉ my new car will get 35 mpg instead of 27 mpg in the business-as-usual case. At 27 mpg and 12,000 miles per year, I would use 444 gallons of fuel. At $2.50 per gallon, that costs $1,110. At 35 mpg and 13,000 miles per year (assuming 8% more miles driven), I would use 371 gallons. Although lower overall demand should push down fuel prices, I’ll assume the same $2.50 per gallon and calculate my annual fuel cost as $928. Thus, my operating cost savings should be $182 per year, $15 per month. The projected average incremental cost of a new high-mileage vehicle will be $1,300, which over the typical vehicle lifetime should be less than $15 per month. Of course, time value of money and various financing options complicate the analysis, but it does seem right that, while the incremental capital cost is not a very attractive investment and may even have a slight negative ROI, CAFÉ is approximately break-even at the individual consumer level.

    Now compare this with the Stavins proposal to change my behavior by increasing fuel prices. Oh, wait a minute. I can’t do that comparison because the proposal doesn’t say how much the fuel price will increase and doesn’t predict how the increase will affect either my new car choice or my miles driven.

    Macro level

    Assuming US sales of automobiles and light trucks recover to about 15 million units per year http://www.bts.gov/publications/national_transportation_statistics/html/table_01_12.html and $1,300 average incremental cost per vehicle, that’s $19.5 billion per year additional cost to consumers. (That’s the total cost of CAFÉ because fuel prices should stay the same or decline versus the business-as-usual case.) The benefit is that we’re pretty sure we’re going to get reduced fuel consumption of exactly what CAFÉ requires, offset by any tendency to drive more miles.

    Compare that to the Stavins proposal. Before the gasoline price spike and recession, the US was consuming about 190 billion gallons per year of highway fuels. http://tonto.eia.doe.gov/dnav/pet/pet_cons_psup_dc_nus_mbblpd_a.htm If each of those gallons were to cost an incremental $1.00, the aggregate cost to consumers would be $190 billion per year (almost 10 times the CAFÉ case), and there is no prediction at all as to benefit in the form of quantified reduced fuel consumption.

    You say, and I agree, that the CAFÉ case achieves benefits slowly because the legacy fleet is unaffected. But if in order to get the whole fleet to 35 mpg the fuel price has to be increased by $2, $3, or even $4 per gallon, that would also have to be phased in slowly to avoid extreme political backlash and severe economic disruption. http://www.econbrowser.com/archives/2009/04/oil_shocks_and_1.html

    I’m persuadable, but so far not persuaded, that Stavins has a better idea.

    Apart from the cost-benefit analysis, I could accept it would make sense to reduce CO2 emissions from the electricity sector first (because it can be done more cheaply there) only if I could ignore (which I can’t) the equally important problems of national security and balance of payments deficits which are specific to imported petroleum.

  6. Roger,
    Thanks for your additional comment. Both because I’m overwhelmed with other work obligations and because I would like to draw others into this conversation, I will not be able to take the time now to respond to your various points above. But I really do appreciate the time and effort you’ve put into the comment, and I hope others will feel free to respond or comment further.
    RS

  7. hapa says:

    robert,

    gar lipow wrote a critique of waxman-markey’s downstream-ness here: http://www.grist.org/article/waxman-markey-bill-would-do-more-for-climate-without-cap-and-trade-provisio/

    i commented that i had noticed your offhand mention of supporting “upstream regulation” and he replied,

    Without commenting on your particular policy, I agree that in a cap-and-trade system the place to require permits is as far upstream as possible. Fossil fuels are still the biggest sources of emissions. Permits for them can be required at extraction or import. However for many other GHG (and even for CO2 emitted when heating limestone during Portland Cement making) upstream and downstream are the same or very close . HFC23 and other non-fossil fuel emissions from industrial production, methane from landfills and mines and so on. Also Agriculture and forestry, for reasons mentioned in the post simply are not suitable for an emissions trading scheme. You need some other way to solve that part of the problem.

    this is FYI — although of course everybody enjoys a good conversation on the most important issues facing humanity in thousands of years.

  8. Mike Risley says:

    Compare that to the Stavins proposal. Before the gasoline price spike and recession, the US was consuming about 190 billion gallons per year of highway fuels. http://tonto.eia.doe.gov/dnav/pet/pet_cons_psup_dc_nus_mbblpd_a.htm If each of those gallons were to cost an incremental $1.00, the aggregate cost to consumers would be $190 billion per year (almost 10 times the CAFÉ case), and there is no prediction at all as to benefit in the form of quantified reduced fuel consumption.

    In this scenario, where does the 190 billion go? Do we burn it? Do we provide health care for poor people? Do we give it to AIG? The benefit of a gas tax is that we can reduce gas consumption and the trade deficit while increasing revenues that could be used to electrify rail. Or to fund a boondoggle that runs on hydrogen which is not as good as a boondoggle that burns money directly but it’s a start (Orlov).

  9. Bill says:

    You have to be careful about what you mean as cap and trade.
    If all existing polluters are allocated rights, then what you have is a barrier to new manufacturers. And, if you are not careful, what you have is an incentive for a company to close manufacturing in the US, sell its pollution rights for a profit, and move to China. You might be better to look at a cap and trade, but with a tax on imported items from countries that do not participate in cap and trade systems.

  10. Bill,
    Thanks for your comment. In a future post, I intend to write about alternative means of “establishing a level international playing field” in the presence of a domestic cap-and-trade system, but for now, I would like to direct your attention to a paper of mine that was published by the Hamilton Project at Brookings, and is available on line.
    RS

  11. Pingback: What Consumers Should Do About CAFE Changes Today - The Dollar Stretcher

  12. I agree, that the CAFÉ case achieves benefits slowly because the legacy fleet is unaffected. But the rates said, do it will be in budget of the people? Without commenting on your particular policy, I agree that in a cap-and-trade system the place to require permits is as far upstream as possible. I consider the point of CAFE its Because CAFE standards increase the price of new cars, the standards have the unintentional effect of keeping older — dirtier and less fuel-efficient — cars on the road longer.

  13. John says:

    CAFE effects our cars and not the mileage we put on them, Now that gas prices have come back down these measures are less effective as a whole.

  14. tayline says:

    Cap and trade makes a good sense at least in the context of political feasibility,
    do it will be in budget of the people? Without commenting on your particular policy, I agree that in a cap-and-trade system the place to require permits is as far upstream as possible.

    http://shipping-vehicles-across-country.com

  15. videosu izle says:

    You have to be careful about what you mean as cap and trade.
    If all existing polluters are allocated rights, then what you have is a barrier to new manufacturers. And, if you are not careful, what you have is an incentive for a company to close manufacturing in the US, sell its pollution rights for a profit, and move to China. You might be better to look at a cap and trade, but with a tax on imported items from countries that do not participate in cap and trade systems.

  16. If CAFE is what is needed to keep the demand of gas and therefore the prices in check then I am on board. The Government needs to get on track with the rest of the world. China, Indian and the countries in the middle east and latin america are going to leave us in the dust if something dramatic is not done. Go team Obama.

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