Obama Administration Archives - Page 25 of 25 - An Economic View of the Environment

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

On My 19^th, 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.

What Baseball Can Teach Policymakers

With the Major League Baseball season having just begun, I’m reminded of the truism that the best teams win their divisions in the regular season, but the hot teams win in the post-season playoffs. Why the difference? The regular season is 162 games long, but the post-season consists of just a few brief 5-game and 7-game series. And because of the huge random element that pervades the sport, in a single game (or a short series), the best teams often lose, and the worst teams often win.

The numbers are striking, and bear repeating. In a typical year, the best teams lose 40 percent of their games, and the worst teams win 40 percent of theirs. In the extreme, one of the best Major League Baseball teams ever - the 1927 New York Yankees – lost 29 percent of their games; and one of the worst teams in history – the 1962 New York Mets – won 25 percent of theirs. On any given day, anything can happen. Uncertainty is a fundamental part of the game, and any analysis that fails to recognize this is not only incomplete, but fundamentally flawed.

The same is true of analyses of environmental policies. Uncertainty is an absolutely fundamental aspect of environmental problems and the policies that are employed to address those problems. Any analysis that fails to recognize this runs the risk not only of being incomplete, but misleading as well. Judson Jaffe, formerly at Analysis Group, and I documented this in a study published in Regulation and Governance.

To estimate proposed regulations’ benefits and costs, analysts frequently rely on inputs that are uncertain — sometimes substantially so. Such uncertainties in underlying inputs are propagated through analyses, leading to uncertainty in ultimate benefit and cost estimates, which constitute the core of a Regulatory Impact Analysis (RIA), required by Presidential Executive Order for all “economically significant” proposed Federal regulations.

Despite this uncertainty, the most prominently displayed results in RIAs are typically single, apparently precise point estimates of benefits, costs, and net benefits (benefits minus costs), masking uncertainties inherent in their calculation and possibly obscuring tradeoffs among competing policy options. Historically, efforts to address uncertainty in RIAs have been very limited, but guidance set forth in the U.S. Office of Management and Budget’s (OMB) Circular A‑4 on Regulatory Analysis has the potential to enhance the information provided in RIAs regarding uncertainty in benefit and cost estimates. Circular A‑4 requires the development of a formal quantitative assessment of uncertainty regarding a regulation’s economic impact if either annual benefits or costs are expected to reach $1 billion.

Over the years, formal quantitative uncertainty assessments — known as Monte Carlo analyses — have become common in a variety of fields, including engineering, finance, and a number of scientific disciplines, as well as in “sabermetrics” (quantitative, especially statistical analysis of professional baseball), but rarely have such methods been employed in RIAs.

The first step in a Monte Carlo analysis involves the development of probability distributions of uncertain inputs to an analysis. These probability distributions reflect the implications of uncertainty regarding an input for the range of its possible values and the likelihood that each value is the true value. Once probability distributions of inputs to a benefit‑cost analysis are established, a Monte Carlo analysis is used to simulate the probability distribution of the regulation’s net benefits by carrying out the calculation of benefits and costs thousands, or even millions, of times. With each iteration of the calculations, new values are randomly drawn from each input’s probability distribution and used in the benefit and/or cost calculations. Over the course of these iterations, the frequency with which any given value is drawn for a particular input is governed by that input’s probability distribution. Importantly, any correlations among individual items in the benefit and cost calculations are taken into account. The resulting set of net benefit estimates characterizes the complete probability distribution of net benefits.

Uncertainty is inevitable in estimates of environmental regulations’ economic impacts, and assessments of the extent and nature of such uncertainty provides important information for policymakers evaluating proposed regulations. Such information offers a context for interpreting benefit and cost estimates, and can lead to point estimates of regulations= benefits and costs that differ from what would be produced by purely deterministic analyses (that ignore uncertainty). In addition, these assessments can help establish priorities for research.

Due to the complexity of interactions among uncertainties in inputs to RIAs, an accurate assessment of uncertainty can be gained only through the use of formal quantitative methods, such as Monte Carlo analysis. Although these methods can offer significant insights, they require only limited additional effort relative to that already expended on RIAs. Much of the data required for these analyses are already obtained by EPA in their preparation of RIAs; and widely available software allows the execution of Monte Carlo analysis in common spreadsheet programs on a desktop computer. In a specific application in the Regulation and Governance study, Jaffe and I demonstrate the use and advantages of employing formal quantitative analysis of uncertainty in a review of EPA’s 2004 RIA for its Nonroad Diesel Rule.

Formal quantitative assessments of uncertainty can mark a truly significant step forward in enhancing regulatory analysis under Presidential Executive Orders. They have the potential to improve substantially our understanding of the impact of environmental regulations, and thereby to lead to more informed policymaking.

Opportunity for a Defining Moment

The inauguration of Barack Obama as the forty-fourth President of the United States is a defining moment in American history. For most Americans and countless others around the world, this is an inspiring political transition. The question we must face, however, is whether compelling inspiration will lead to effective action. As I wrote in a Boston Globe op-ed (November 12, 2008) one week after election day, environment and energy issues — particularly climate change policy — provide a microcosm of the forces that are shaping and will shape the actions of the new Administration and Congress.

About eight years ago, President-Elect George W. Bush promised to be President for all the people, not just those who had voted him into office. Bush’s ability as Texas Governor to bridge differences across the political aisle provided cause for optimism.

But hope for a centrist and sensible Presidency dissolved under the influence of White House political operative Karl Rove and Vice President Dick Cheney. The Bush Administration moved not to the center, but toward solidifying its base on the political right. Nowhere was this more apparent than in energy and environmental policy, with Vice President Cheney running energy policy, and EPA Administrator Christie Whitman virtually driven from office.

Will the environment and energy team of President Obama respond effectively to the serious challenges that lie ahead? Or will we find that the corporate lobbyists who filled so many key environmental positions in the Bush Administration have simply been replaced by strident advocates from the other end of the political spectrum? In other words, will ideology trump reason?

The first sign of trouble will be if the Administration issues an “endangerment finding” for carbon dioxide, as promised by the Obama campaign, thereby pleasing and solidifying President Obama’s political base, but also playing into the hands of those who oppose climate policy action, tying up progress with litigation, driving up costs, and accomplishing little or nothing.

Ultimately, will the Obama White House work with Congress to develop climate strategies that are scientifically sound, economically sensible, and thereby politically pragmatic? Will the new President –with impressive Democratic majorities in both houses of Congress — take on the difficult task of crafting meaningful climate legislation?

The only politically feasible approach that can make a real dent in the problem is a comprehensive, upstream cap-and-trade system to reduce carbon dioxide emissions 50 to 80 percent below 1990 levels by 2050. The declining cap will increase the cost of polluting, thereby discouraging the use of the most carbon-intensive fossil fuels and providing powerful incentives for energy conservation and technology innovation.

The system could start with a 50-50 split of auctioned and free allowances, gradually moving to 100% auction over 25 years. To establish political support in the short term, free allowances should be targeted to sectors that are most burdened by the policy. And the auction revenue — which will increase over time — can be used to compensate low-income consumers, finance research and development, reduce the federal deficit, or cut taxes.

The best option may be to make the program revenue-neutral by returning all of the auction revenue to citizens through direct cash dividends or annual tax credits. This can go a long way towards making the legislation palatable to Republicans and Democrats alike who are reticent to take any actions that even resemble a tax increase.

By making the overall emissions cap gradually become more stringent over time, costs can be greatly reduced by avoiding premature retirement of existing capital stock, reducing vulnerability to siting bottlenecks, and ensuring that long-lived capital investments incorporate appropriate advanced technology.

Still, the costs of meaningful action will be significant, with impacts on gross domestic product eventually reaching up to 1 percent per year. But the longer the world waits to begin taking serious action, the more ambitious will emission reduction targets inevitably become, as atmospheric greenhouse gases continue to accumulate.

The bottom line is that getting serious about global climate change will not be cheap and it will not be easy. Beware of claims to the contrary. In the midst of a significant economic downturn, with businesses closing and unemployment on the rise, it makes sense for the new Administration to give its greatest attention to economic recovery. There is nothing wrong with sequencing policies. But if current predictions about the consequences of another few decades of inaction are correct, this defining moment provides an important opportunity for serious and sensible action.