On the inefficiency of fuel efficiency standards

Imagine you have just been pulled over for exceeding the speed limit. The officer explains that the penalty for speeding decreases with engine size. Why?  Because it is relatively more difficult for drivers of high performance cars to exercise restraint and drive the speed limit. What?!

blogp1          Ma’am, if you had more horsepower,  this fine would not be so high.

Photo credit: http://www.dmv.org/articles/traffic-stop-dos-and-donts/

Of course, this is not how speeding ticket fines are actually determined. But this scenario serves as a metaphor for how the fuel economy standards faced by automakers are actually set.

The bigger the car, the lower the bar

The U.S. Corporate Average Fuel Economy (CAFE) standards establish a minimum average fuel economy limit for each manufacturer’s domestic vehicle sales.  Historically, all passenger cars were held to the same fuel economy standard (27.5 miles per gallon in 1990-2010).  Light trucks faced a less stringent standard.

This all changed when Congress mandated attribute-based standards as part of the Energy Independence and Security Act.  The graph below illustrates how fuel efficiency standards are now determined based on vehicle “footprint” (i.e. the area defined by the points where the four wheels touch the ground).  Each company calculates the CAFE requirements for every model it brings to market. Company-specific fuel economy limits are defined as the sales-weighted average across vehicles sold.  In other words, companies selling bigger cars are held to a less stringent fuel economy standard.

car-and-truck-stds

Source:http://blog.ucsusa.org/what-makes-a-car-a-truck-and-why-it-matters-for-fuel-economy

Why un-level this playing field?

One possible argument for moving from a one-size-fits-all to a size-based standard has to do with minimizing the costs of meeting fuel efficiency targets. In general, it is more costly for firms that make larger, heavier cars to meet a given fuel efficiency target. An attribute-based standard could- in principle- be designed to equate marginal compliance costs across firms. This would ensure that fuel economy targets are being met at least cost.

In the U.S., however, the ability of firms to trade credits eliminates this efficiency-advantage. Instead, the National Highway Traffic Safety Administration (NHTSA) offers the following justifications for the current footprint-based standard (details can be found in the final rule and public hearing transcripts).

  • Reduce disparities of manufacturers’ compliance burdens”: U.S. manufacturers produce relatively large vehicles.  Footprint-based standards reduce the compliance costs borne by US automakers vis a vis their international competitors.
  • “Preserve consumer choice”:  It is more costly for larger vehicles to meet a flat standard.  Drivers who prefer/need larger vehicles would either need to pay a higher price for their vehicle or choose a smaller vehicle. Reduced demand for large vehicles could reduce supply. NHTSA has been very concerned about mitigating these kinds of impacts.

NHTSA has also argued that “attribute-based standards reduce the incentive for manufacturers to respond to CAFE standards in ways harmful to safety.”  This presumes that downsizing vehicles would make driving less safe. But recent studies have found that, once the safety externalities associated with driving larger vehicles are accounted for, the current vehicle fleet looks inefficiently large.

Looking out for the big guys….at what cost?

The problem with using attribute-based standards to reduce impacts on the producers and consumers of larger vehicles is that it creates an incentive for firms to game the system. More specifically, attribute-based standards provide an incentive for manufacturers to adjust the attributes of the vehicles they sell in order to reduce the stringency of their firm-specific targets.  This is potentially problematic because bigger, heavier vehicles tend to consume more gas, emit more pollution, and are associated with higher traffic fatalities.

A recent working paper by economists Koichiro Ito and Jim Sallee provides a striking example of how this kind of gaming can play out in practice. They focus on firms’ response to Japanese fuel economy standards. The stair-step pattern in the graph below shows how the Japanese fuel efficiency standard drops discretely at pre-determined vehicle weight thresholds.

blogp3

Weight of cars sold under Japanese fuel economy regulations 

Koichiro and Jim note that, for firms manufacturing vehicles that are close to a weight threshold, a small increase in weight will deliver a relatively large reduction in the fuel economy standard.  They cleverly use these notches to test whether Japanese automakers have in fact  “upweighted” in response to the standard.

The green bars in the graph summarize the distribution of weight among vehicles sold in Japan. The height of each bar tells you the percentage of vehicles that fall within the corresponding 10 kg weight range. Looking at the bunching of vehicles just to the right of each cut-off, it sure looks as though automakers are upweighting in response to this policy. The authors build a very convincing case for this interpretation. And they argue that the costs associated with this policy-induced upweighting are substantial.

Are we being super-sized?

There are reasons to think that manufacturers’ response to Japanese standards will be more dramatic than anything we will see here in the U.S.  For one thing, Japanese standards are based on vehicle weight which is more easily manipulated.  And there is no trading of compliance obligations in Japan.

But there is anecdotal evidence that cars are getting bigger under the new CAFE standards here in the United States:

blogp4

Range Rover features a new “long wheelbase” at the 2014 Detroit Auto Show.                 Photo credit: Catie Hausman

A recent news article reports that sales of large cars and trucks are up.  My co-author Kate Whitefoot has done terrific work investigating the potential design response to footprint-based standards. She has more recently been looking at the 2013 data and finding that the sales-weighted average footprints of cars and light trucks are larger than was projected in the regulations.

Attribute-based standards are a potentially costly way to allocate compliance costs more equitably. If auto manufacturers are significantly increasing the size of the vehicles they sell in response to the current size-based standards, fuel economy targets will not be met efficiently. Calls to flatten the curve that maps footprint to efficiency standards should be taken seriously. Or we should find an altogether different way to redistribute costs. Think pollution permit trading programs that use free permit allocations to achieve distributional objectives without undermining market efficiency.  There are ways to mitigate the cost impacts of fuel efficiency standards on the big guys without creating an incentive for them to get even bigger.

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8 Responses to On the inefficiency of fuel efficiency standards

  1. Seth Kaplan says:

    A very good post with a flawed headline. It is not about “the inefficiency of fuel economy standards” in general it is a practical critique of a new version of the standards that the Federal Government has adopted in response to political, social and economic pressures.

    • Meredith Fowlie says:

      Hi Seth-

      Thanks for the comment. The title was intended to refer to attribute-based fuel economy standards that are being implemented in the US and elsewhere (e.g. Japan). The point i was trying to make is that there are ways to respond to political pressures without compromising the integrity/efficiency of the policy. But i appreciate your comment and the clarification. thanks for reading

    • Carl Blumstein says:

      This is a great post but I agree that the title is a bit misleading. You should change the title to “On the Inefficiency of Attribute-Based Fuel Economy Standards.” There are people who believe that any fuel-economy standard would be inefficient but that is not what you are saying.

  2. Steve Plotkin says:

    A few comments. First, it is no surprise that the Japanese system creates strong gaming opportunities….if one is selling a vehicle that weighs a bit less than the regulation’s “break point,” it makes perfect sense to kick the weight up a bit to gain a much more lenient standard (by moving up a full weight class). That’s precisely the reason why the National Highway Traffic Safety Administration chose a continuous standard for the U.S……to avoid just such gaming. As for increasing wheelbases in the U.S. fleet — such increases may achieve a bit of advantage regarding fuel economy standards, since the result is a slightly less stringent standard…..but increasing the wheelbase of a vehicle requires substantial re-engineering, and it is not decision taken lightly…..and the increase should have a positive effect on vehicle handling. And if increasing wheelbase increases weight, that will make it more difficult for the manufacturer to satisfy the standard….unless overall vehicle length remains the same, the net effect is likely to be no net gain for the manufacturer. Finally, I don’t understand why “the ability of firms to trade credits eliminates this efficiency-advantage”….credit trading increases economic efficiency by allowing firms to focus efficiency measures on those vehicles where the measures are most cost-efficient. In my view, attribute-based standards are a reasonable approach to CAFE standards, and the government’s choice of footprint makes a great deal of sense.

    • Meredith Fowlie says:

      Hi Steve-

      Thanks for the response and highlighting a point that may have been less-than-clear. You were confused by the following: “the ability of firms to trade credits eliminates this efficiency-advantage”. My point is as follows. This trading provision will – in principle- equate marginal compliance costs across firms. If the trading provision is achieving this efficiency result, this obviates the need for an attribute-based standard whose sole intended purpose is to allocate compliance activities cost effectively across firms with different costs. Absent this efficiency argument, the main justification for attribute-based standards are distributional arguments.

      • Steve Plotkin says:

        I agree that trading provides an industry-wide efficiency….but that doesn’t make attribute based standards “inefficient”…..and the distributional effects of attribute-based standards are a strong benefit if one wants to treat manufacturers fairly….and avoid the political costs of seeming to favor manufacturers devoted to small cars. Of course, if one wants to push people into smaller cars, attribute-based standards look bad….because they basically let people choose larger or smaller vehicles depending on their needs. Eye of the beholder.

  3. Gary Stern says:

    While your basic premise that the attribute based standard results in some potentially perverse incentives and gaming opportunities, and I certaibnly agree with the main points, there is another aspect of the allowance for reduced standards for larger vehicles that you have not captured. Larger vehicles allow for the potential for more passengers to be transported. Utimately the efficiency we are attempting to achieve should be reducing the energy use associated with satisfying total travel needs. A 35 mpg vehicle that transports 2 passengers is less efficient than a 25 MPG vehicle that transports 5. Of course this vastly complicates the analysis since having a vehicle capable of transporting more passengers certainly doesn’t mean it typically will transport more passengers. Clearly in the extreme, however, there is a flaw with making standards independent of vehicle size, as buses would be eliminated.

    • Bill Henry says:

      Gary,

      If you have a vehicle that can transport more people, should you not have to directly face up to the fuel consumption consequences of such a choice? You point out the main flaw in your argument – that there’s no way to be sure the high passenger carrying capability would actually be used. If there was an absolute fuel economy standard, higher passenger capacity vehicles would be more expensive, but the operation cost probably still pencils if they really are used to transport more people. Then operators of such vehicles would have a stronger incentive to make sure they always use them that way.

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