A Second Act for the CAFE Standards

21 May 2009 at 3:23 pm Leave a comment

| Peter Klein |

From former guest blogger David Gerard:

As you have no doubt learned, President Obama and Governor Schwarzenegger have teamed up for a healthy bump in the federal Corporate Average Fuel Economy (CAFE) standards, forcing automakers to boost their fleet averages to 35 miles per gallon by 2016. The announcement will dismay many economists, who for many, many reasons have advocated steeper gasoline taxes instead. Lester Lave and I argued that that there were some solid reasons to support some form of CAFE standards in conjunction with higher gasoline taxes. On pragmatic grounds, the CAFE standards have enjoyed public support and gas taxes decidedly have not, so CAFE has carried the day.

The original CAFE measures did not do much in terms of pushing the envelope of vehicle technology, as a change in consumer tastes toward more fuel efficient vehicles in the late 1970s. As a result, the standards were met by altering the mix of vehicles sold, not by any radical improvements in technology. It wasn’t until the early 1980s when oil prices tanked that the CAFE became a serious binding constraint. In contrast, the CAFE standards announced Monday are very aggressive. However, setting the standard is only the first part of the story. The real action takes place during the second act. What happens as the deadline approaches if firms are unable to meet the stricter standards?

The history of the U.S. auto industry has a number of cases of such technology-forcing standards. Lester and I looked at two cases of technology-forcing regulations facing the U.S. auto industry, where technology forcing is defined as a standard that firms cannot meet with currently available technology, hence forcing the development of technological change. The game theoretic technology-forcing models pit a regulator against a firm, and predict that firms will either comply with the strategy or miss by a lot. The intuition is that regulators will enforce a standard if firms are close to meeting it, but will generally lack any credibility to enforce a standard that appears to be technologically infeasible. This is especially true when talking about large manufacturers with a large number of union employees on its payrolls.

The 1970 Clean Air Act legislation requiring the regulation of automobile emissions is instructive. The legislation required 90% reductions of hydrocarbons and carbon monoxide by 1975. This effectively required firms to equip vehicles with catalytic converters at about $250 per vehicle. Chrysler was in no financial shape to do R&D on catalytic converters, let alone put the devices on its vehicles. When the deadline came, Ford and GM equipped their vehicles, but Chrysler did not. The EPA did not shut down or even penalize Chrysler, but rather allowed the company to “comply” without using catalytic converters. As a result, the Chrysler vehicles had significantly higher emissions than the GM and Ford vehicles. As a lesson in regulatory fungibility, it is noteworthy that GM vehicles didn’t actually meet the 1975 standards until 1993.

Certainly, the game has changed. The U.S. automakers are no longer the “Big Three,” with dominant market share and significant political influence. The players may have changed as well, as the lines between the regulator and the firm have blurred sufficiently to change our basic model. The Administration now exerts direct control over Chrysler, and now has an interest in having these standards met. I think what this adds up to is that we will see considerably more government resources directed toward meeting these standards. This might come in the form of subsidies for implementing fuel-efficient technologies, or an expansion of some of the healthy tax credits we have seen for the purchase of hybrid vehicles. The real drama of these new CAFE standards will be playing out for years to come.

Entry filed under: - Klein -, Former Guest Bloggers, Institutions, Law and Economics, Public Policy / Political Economy. Tags: .

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