A Tale of Two Standards
Economists have long complained about Fuel Efficiency standards. Are we happy now?
The past 50 days felt like the beginning of a game of environmental policy Jenga. The new administration is starting to pull pegs from the tower of environmental and energy regulations slowly built up over the past 50 years. Whether this tower will crumble is a legal question, which I am not qualified to comment on, so I’ll stick to economics.
Maybe the most significant development is President Trump’s call for a review of the Corporate Average Fuel Economy standards, which were updated under the Obama Administration requiring the auto industry to deliver a fleet average of at least 54.5 mpg by 2025. This means that the average new car sold would achieve roughly the fuel economy of a current day Toyota Camry Hybrid. This is no doubt ambitious and US manufacturers have complained publicly about the significant costs this would entail, which would be largely passed through to consumers (or so they claim).
Let’s think about the economics of standards for a minute. Standards come in as many flavors as Ben and Jerry’s ice cream. The CAFE standard was introduced after the 1973-4 oil embargo and is so complex that a number of my colleagues are spending significant parts of their careers understanding it and its consequences. The most recent version of the standard regulates vehicles by class (passenger cars vs. light trucks) and within class by footprint (trackwidth times wheelbase). The table below shows what the proposed standards are trying to achieve (Source: Wikipedia. Sue me.)
If you do the back of the envelope calculation, this is equivalent to a roughly 28% improvement in gallons per mile (the right measure) from the 2017 model year to 2025 for all passenger cars and small footprint light trucks and a 17% improvement for the bigger “light” trucks. This sounds like a lot. And the car industry is crying wolf. A number of think tanks are immediately translating this burden into massive domestic job losses. However, if you read the collected works of the brilliant former EI student Chris Knittel, you will know that auto manufacturers have funneled technical progress into more power rather than into more fuel efficiency. For example, a 1980 Honda Civic in its base model had 55 horsepower which got 34 mpg. The 2017 base model has 158 horsepower and gets roughly 35 mpg. Same fuel economy – thrice the power. The argument has forever been: “Power. It’s what consumers demand”. Chris’ paper suggests that the historical improvements in fuel efficiency amounted to about 2% per year. The Obama goals are about 3% a year. So an acceleration would be required, yet it’s not a moonshot.
The issue is of course that emissions of greenhouse gases and local pollutants from the transportation sector in the United States account for 26% of greenhouse gas emissions and a significant share of local pollutants – toxics and particulate matter. It is well understood that there is an underlying market failure, whereby consumers do not pay for the full social cost of their actions resulting in excessively large emissions of these damaging compounds.
Consumers left alone have no incentive to do the right thing. The regulator is supposed to step in here and provide consumers with incentives to make socially optimal decisions. An emissions tax is the first best thing to do. In its best version there would be a separate tax for the local pollutants and the global pollutant. We would cheer loudly.
A gasoline tax is second best. Half of us would clap.
A very distant third+ best is a standard, such as the CAFE regulation discussed above. Hence the average economist would have gladly done away with these standards in exchange for the more efficient policy instruments. CAFE standards have significantly reduced emissions of greenhouse gases by increasing the fuel economy of the fleet. One can make nice arguments about how this has benefitted the US in the form of less reliance on foreign oil as well. However, it is also clear that these standards are an expensive and inefficient way to regulate these emissions.
So, you ask, do all economists hate all standards? The answer is no. At least for this economist, there are many standards that make a great amount of sense. Take for example appliance standards. The individual consumer frankly has no idea how much electricity a refrigerator consumes. In fact, I would wager that the average person would have no idea what units electricity is measured in for billing purposes and what price they pay (I am not even hoping for knowledge of marginal price). Since the customer does not observe this information, (s)he has no incentive or ability to make an efficient investment decision when it comes time to buy that new fridge. Appliance standards set targets that regulate the energy efficiency of these durable devices, so we get an average efficiency of appliances moving us closer to a privately and socially optimal level of electricity consumption. So, in settings where the efficiency of a device is not observable, I am gung ho for technical standards (that optimally would also take into account the extensive margin – size – of the device as Ito and Sallee point out).
For gasoline, this is not the case. The vast majority of consumers know how many miles their car goes on a tank and how much it costs to fill a tank. They hence observe the efficiency of the equipment when they purchase it. It is on a big label on each vehicle in fact. This is admittedly also true of refrigerators. However, in real world usage situations where your teenager floors the car at each traffic light and opens the refrigerator door 48 times a day to see what’s in there, it is much easier to gauge the car’s consumption of gas than the fridge’s consumption of electricity. Many of us would argue it would be much more effective to price the emissions (and safety) externalities of vehicles directly instead of regulating them via an inefficient fuel economy standard.
But, and this is a big “but.” Like HUGE. If the choice is between a CAFE standard and no regulation, I might very begrudgingly take the CAFE standard. I would assume that not all environmental economists would agree on this point, since CAFE is an extremely expensive way of regulating carbon emissions. Jacobsen (AEJ 2013) finds that the old CAFE standards cost a whopping $616 per ton of CO2 abated. But it does not only regulate carbon emissions, it indirectly also controls vehicle weight to a certain degree, which Michael Anderson and I show has significant external costs in terms of fatality and injury risk in collisions. CAFE is far from efficient, but it does regulate the externality, which is massive. Maybe the most powerful, but least well documented argument in favor of CAFE is it will somewhat accelerate technological progress, and some of that will spill over into the rest of the world’s markets. And the rest of the world is buying a boatload of cars.
Abandoning any kind of emissions regulation from the transport sector is simply wrong. It’s basic economics. While I see no chance for a reasonable carbon tax (say $39 ton or higher), I would hope that reasonable voices on the hill would continue to push for one. In the meantime, CAFE standards to me are better than no regulation.
I like a good game of Jenga. But when the tower crumbles, we will bury future generations’ welfare under a pile of pollution. This is not what we should be doing.
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Maximilian Auffhammer View All
Maximilian Auffhammer is the George Pardee Professor of International Sustainable Development at the University of California Berkeley. His fields of expertise are environmental and energy economics, with a specific focus on the impacts and regulation of climate change and air pollution.
Energy Institute Blog 
Max – as usual, I continue to be perplexed by the world as seen by economists – if it were only perfect, then clearly the market would function ‘perfectly’ and we’d all make economically rational (or, I guess in your view, economically efficient) choices. But… that perfection also requires perfect knowledge about externalities and how to price them (I know, the idea of economic factor external to the market is something you’ve heard from me before – sorry to be so repetitive). And carbon emissions are only one of them.
I’m happy that you think appliance efficiency standards are a good thing – from where I sit, the regulation of automobile fuel efficiency (and in California at least, emissions) is largely parallel. They are both complex in terms of direct economic issues (cost at the meter/pump vs buying a perhaps more expensive, but more efficiency appliance/vehicle. And there are the externalities – air pollution and its effect on health (poorly if at all captured by any sort of market), greenhouse gases, sustainability in terms of natural resource use, etc. For users of gasoline, the price at the pump has hardly been a consistent market indicator. Since I can’t seem to paste in the nifty gasoline price chart from the EIA – here’s an edited version of the same data from their table – largely a consistent downward trend in constant dollar gasoline prices from about 1929 to around 1998 when prices started to increase and then dropped precipitously in the past three years. I’ve included the prices for the 1973 – 1985 period also.
year current 2015$
1929 0.21 2.38
1930 0.20 2.30
1931 0.17 2.18
1932 0.18 2.61
1973 0.39 1.62
1974 0.53 2.03
1975 0.57 1.98
1976 0.59 1.96
1977 0.62 1.94
1978 0.63 1.83
1979 0.86 2.31
1980 1.19 2.95
1981 1.31 2.97
1982 1.22 2.60
1983 1.16 2.37
1984 1.13 2.23
1985 1.12 2.14
2012 3.64 3.80
2013 3.53 3.62
2014 3.37 3.40
2015 2.45 2.45
Gasoline prices aren’t coupled – at least in any rational way that I can discern – to resource extraction costs, so its hard to see what incentives the consumer sees – other than the fact that gasoline prices haven’t gone up much – other than over short periods.
I would argue that CAFE standards have been a big technology driver – especially for reductions in vehicle emissions. The importance of these reductions cannot be overstated, as there is a growing volume of literature (journals such as Environmental Science and Technology, Indoor Air, Atmospheric Environment, Environmental Health Perspectives, to name but a few) looking at the serious impact of ultrafine particles to human health (I’ve noted two such papers at the end). In many urban areas, motor vehicle emissions are a significant emission source of ultrafines. The economics of the health outcomes are just now being understood.
Indeed, one of the reasons for Toyota developing/marketing the hybrid was to bolster their CAFE numbers – VW bet the farm (almost literally) on turbocharged diesels – achieving high fuel efficiency but at the expense of terrible emissions problems (as we now know) – emissions that apparently could have been better controlled (at greater expense, of course).
I assume your ‘gun to the head’ grudging acceptance of fuel efficiency regulation is a bit of economic hyperbole – otherwise we let the perfect become the enemy of the good enough. And good enough – on average – is about all we can expect from our current politics whose idea of economic rationality is to bolster corporate bottom lines with little concern for the external consequences.
A couple (of many) references:
[1] A. Isen, M. Rossin-Slater, and W. R. Walker, “Every Breath You Take – Every Dollar You’ll Make: The Long- Term Consequences of the Clean Air Act of 1970,” UC Center for Energy and Environmental Economics, Berkeley, CA, WP-076, 2014.
[2] Y. Zhu, W. C. Hinds, M. Krudysz, T. Kuhn, J. Froines, and C. Sioutas, “Penetration of freeway ultrafine particles into indoor environments,” Journal of Aerosol Science, vol. 36, no. 3, pp. 303–322, Mar. 2005.
An unpublished finding in one of Chris Knittel’s papers is that the CAFE standard actually didn’t drive improved fuel economy until the oil prices collapsed in 1984. (I had a long discussion with him about this.) Prior to that consumer demand, not standards, was leading to higher fleet efficiency–the CAFE standard was nonbinding. Fuel prices are a powerful driver based on this evidence. Right now the fuel price doesn’t include all of the externalities so it doesn’t incent improved efficiency, but we know that it could.
So, yes the CAFE standard has driven technology innovation, but only because we haven’t really tried the economists’ preferred alternative–a higher gasoline tax.
However, an important problem is that the higher fuel price can be regressive because it is more difficult for lower income households to buy their way out of the problem with a new car purchase. That’s a separate issue, but one that should not be ignored.
I’m not sure that CAFE standards and gasoline taxes are mutually exclusive – arguably they co-exist now, though it has been a very long time since gasoline taxes have gone up. There’s been no political will to do so. I don’t agree that one should separate the regressive features of a higher gasoline tax and its public policy implications – without some sort of mitigation plan coupled to the taxes, it becomes a very heavy lift politically (at least it should be). I give you what the Repubs thought they were gonna do regarding repealing the ACA and leave the details of what to replace it with ’til much later as exhibit A – with Exhibit B being the cobbled together mess they’ve created because plan A wasn’t going to work (neither is plan B, IMHO).
What troubles me most about all the talk of economic ‘rationality’ or ‘efficiency’ is that I don’t think economic efficiency and environmental (policy) efficiency are the same thing. If one’s goal is to reduce greenhouse gas emissions – and along with it the particle and NOx load in urban areas due to vehicles – not to mention the benefits of reducing/eliminating the environmental consequences of extraction, refining, etc., its hard to see how to do all of that with efficient economics. And efficiency in this context must include some sense of urgency.
On “effiiciency”: Economic efficiency metrics include societal costs. Those include “the benefits of reducing/eliminating the environmental consequences of extraction, refining, etc.” Too often, those who advocate “free market” solutions that are “efficient” ignore the fact that those markets require that ALL property rights be fully defined. Keep in mind that most economists (rather than lawyers, engineers and political consultants) agree that efficiency metrics must include the broader set of costs and benefits you’ve defined.
In the spirit of accuracy, Max’s followng statement is inaccurate: “Maybe the most significant development is President Trump’s call for a review of the Corporate Average Fuel Economy standards.” In fact Trump called for a reiew of the GHG performance stds, not the CAFE standards. CAFE is administered by NHTSA (part of US DOT), while the GHG stds are administered by EPA. Obama’s EPA made a deteremination in January that the standards set for 2025 back in 2012 should be retained. Trump is forcing EPA to rescind that determination by EPA. (for GHG stds, not CAFE stds). NHTSA never made a determination for CAFE stds and is now involved in a slow process to do so, seperate from but coordinated with EPA. The principal asks of the auto industry are to remove inconsistencies between NHTSA, CARB, and EPA stds. They never asked for a rollback (though that is what Trump called for during the campaign). Indeed there are many small fixes that would be desirable from an environmental and administrative/regulatory perspective.
Max, glad to year you’re staying on, but come on, saying the auto industry cried wolf is simplistic.
Bloomberg reported it more helpfully: “In a Feb. 10 letter, executives including Mary Barra of General Motors Co., Ford Motor Co.’s Mark Fields and Fiat Chrysler Automobiles NV boss Sergio Marchionne asked Trump to return the [EPA’s mid-term] review to its original schedule, giving the new administration a chance to shape the outcome.”
In addition to finalizing new CAFE standards, a full term review would allow automakers to make the case they expected to in a Clinton EPA: unexpectedly low gas prices have encouraged consumers to flock to less fuel-efficient cars, making it significantly harder for automakers to meet the standards.
A price on carbon would tilt things back the other way. And so, what perplexes is me why automakers— if they don’t like the vagaries of fluctuating regulatory standards— don’t advocate for a price on carbon as an alternative.
The cost of everything and the value of nothing. This is why (capitalist) economics is destructive. Sustainable development means sustainability of the earth. This really means all of the available choices at this point. Professor Auffhammer should resign since he obviously does not know what sustainability means. Oh yes, I am a climate scientist with a real science degree not a faux science like economics.
Will tender my resignation immediately in response to an anonymous comment.
we love you, max!!
Good post, as usual. But while consumers know their MPG and fuel costs, do they sufficiently know their environmental impacts? And are today’s price signals alone sufficient for inducing behavioral change and achieving emissions reduction goals?