Lemons From Lemonade

There’s a reason they call it the “dismal science.” Just when we think we’ve done something we can feel good about, the economists show up to rob us of some of our hard-won self-satisfaction.

In case you missed it, the Obama administration just decided to dramatically increase fuel economy standards nationwide. The new regulations mandate that by 2016 the fuel economy of new cars and light trucks sold in the U.S. increase to a combined city/highway m.p.g. of 35.5, up from about 27.9 under today’s CAFE standards.

Although hybrids and electric vehicles can help automakers meet these targets, enough efficiency can be reaped with internal combustion autos. This can come through improvements to things like tires, engines (e.g. smaller ones with turbocharging), air conditioning, transmissions, and vehicle weight. The administration estimates that this will cost $1,100 per vehicle but that the improvements will pay for themselves with $3,000 in fuel savings over the life of the car.

Cleaner air, a cooler planet, fatter wallets, and slimmer trade deficits; O.K., economists, what’s not to like?

The problem is that lurking beneath the regulations’ noble intent lie some perverse incentives which may cause unintended consequences. These tend to pop up in transportation: improved auto safety technology may induce us to drive more dangerously, and by reducing congestion, investments in mass transit may cause some people to drive who ordinarily wouldn’t have.

Previously, I blogged about the rebound effect, which dictates that some of the gains from improved fuel efficiency will be eroded as drivers respond to lower gas costs by driving more. Kenneth A. Small and Kurt Van Dender of the University of California at Irvine estimate that about 10 percent of the fuel savings from better mileage will be dissipated thanks to increased vehicle miles traveled.

And there’s more, according to a new paper (gated) by Lawrence H. Goulder, Mark R. Jacobsen, and Arthur A. van Benthem.

According to the authors, the increase in new car prices that will result from incorporating fuel-saving technology will make used cars more valuable. To avoid shelling out for new models, drivers will have an incentive to keep aging, fuel-hungry vehicles on the roads and off the scrap heap. The authors estimate that 24 to 39 percent of the fuel savings from adoption of the new standard will be lost as a result of prolonging the life of the used car fleet.

The authors are also less sanguine than the administration about the monetary savings from this initiative. In part due to the used car effect, they calculate the new standards will cost about $4.50 to $6.00 per gallon of fuel saved. Given the external costs of fuel consumption, such as pollution, I feel this tradeoff is worthwhile. But backers’ claims that the new standards will pay for themselves may be misplaced, at least without a big runup in gas prices.

Perhaps the picture is not as grim as the authors paint. They did not take the effects of Cash for Clunkers into consideration; 700,000 of our most gas-guzzling used cars have just been taken off the road entirely.

Also, depending on the models involved and their mileage, keeping used cars around a bit longer may ultimately have benefits for the environment, given the energy that goes in to building a new car (see this or this). Finally, there is a chance that technological improvements will eventually reduce the cost of the new fuel efficiency measures.

Still, some of the effect the authors predict will be felt; the lifetimes of some inefficient cars will be extended thanks to the new standards. Leave it to the economists to turn our lemonade into lemons — as in more lemons on our roadways.


Rob

These economists are only right if gas stays under $3/gallon. When it was up past $4 before the recession hit, guzzlers were worthless and hybrids were selling at premiums beyond their manufacturing cost.

Chris Manly

And all this brings us back to the painful reality that the only way to actually reduce fuel consumption is to tax the fuels heavily. That builds all the right incentives in up front and simply, but it will never happen.

Jeff

"The authors estimate that 24 to 39 percent of the fuel savings from adoption of the new standard will be lost as a result of prolonging the life of the used car fleet."

... Till when?? In 2021, the used cars starting to be available will ALL have the higher mileage standards. Without the standards increase, used cars would continue to be the lower mileage they are right now.

I was worried you were going to say the President had done something sane like mandate that mileage be measured in gallons per hundred miles!

aaron

You call it induced driving, I call it economic stimulus.

aaron

You really believe there's $2 to $3.50 of negative externalities per gallone of fuel?

JimBob

700,000 gas guzzlers were not 'taken' off the road. Some of those were actually real 'clunkers' with little real use. I know because my Dad turned one in. It worked, but it sat on the side of the house for towing the boat out of the water 2-3 times a year. Some savings. Glad I could pay taxes for that.

Michael

"And all this brings us back to the painful reality that the only way to actually reduce fuel consumption is to tax the fuels heavily. That builds all the right incentives in up front and simply, but it will never happen."

It really couldn't be more simple, yet our government runs around the issue like a chicken with its head cut off.

Imad Qureshi

I don't agree with this analysis. Assumption that people will driver more because of lower fuel prices basically means that demand will go up and prices will increase. So you are ignoring equilibrium. I find your reasoning flawed.

Steven

...and which economist or blogger has figured in the cost of maintaining carrier battle groups in oil-rich parts of the world to protect a continuous supply of oil for said gas-guzzlers? I haven't heard one peep about that.

Ben

Eric - great points. What a bunch of morons (and corrupt liars) our politicians are. I wish you'd take your points to their logical endpoint and join the Pigou Club.

AgentG

There is no change scenario that will not bring some kind of potential disadvantage. One can always find some fault or hidden cost in our complex markets. You also forgot to include the geopolitical dimensions of oil dependency and risks through huge price fluctuations.

The negative comments are nothing other than nit-picking. In fact, it reeks of neurotic ambition to tear down any good idea. The very essence of economics is coming to terms with trade-offs. We need to think of bigger goals that simply money. You can't eat or breathe money, so if more fuel efficiency gives us better cars and less dependence on oil, the price is what it is and it is worth that price.

PaulK

New technology comes down in price faster when more are in production. Once you have that requirement, every car company will be working to drive down the cost of the technology. The changes in CAFE have pushed technologies and also encouraged more companies to get into the supply side of the equation, including new battery technologies. When there are a few better batteries (not just one), the price will drop dramatically. There are plenty of people who want to capture that volume, and many will be happy to compete on price.

Valpey

“And all this brings us back to the painful reality that the only way to actually reduce fuel consumption is to tax the fuels heavily. That builds all the right incentives in up front and simply, but it will never happen.”

Indeed. This and many other efficiencies could be realized were it not for the small-state bias favored by US Politics. While the small-state bias inherent in the makeup of the Senate is not likely to change soon we do have an opportunity to affect the small-state bias (or swing-state bias) inherent in the election of the President.

I refer to the National Popular Vote Interstate Compact which would give the Presidency to the winner of the national popular vote (something favored by a majority of any political party or demographic group).

My State of Washington joined the compact this year following the likes of IL, NJ, HI, and MD and bills are pending in many more states like FL, NY, MA, MN, NH, OR, NE, MO, OK, MS, VA, GA. I'd like to believe my lobbying my State Representatives and Senators made a difference and think you could too. On quiet issues like this, our reasoned opinions are more meaningful and more likely to resonate.

Reasonable proposals such as the pigovian taxation of fossil fuels is a very long term project, and we are going to need to change some of the fundamentals of the system first.

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Ted

I dislike the oft-used line of reasoning that making cars (or anything) more efficient will just drive increased usage, thereby erasing any reduction in fuel. Even if fuel consumption stays constant, now people will be happier by driving more miles for the same price.

Andrew

Assuming 2.28 kg of carbon dioxide is produced from burning one litre of fuel, a pollution externality of $2.50-$3 per gallon of fuel implies a carbon price of $210-370 per ton of carbon dioxide ($770-1350 per ton of carbon), or between 3-5 times more than the price recommended in the Stern Review, and 25-50 times the price recommended by William Nordhaus.

rick

This is a long term solution. Yes people will keep their cars longer but eventually they just wear out.

Philippe

In France gas is already heavily taxed and some of the money is used to subsidize public transportation. This shifts the equilibrium towards taking the bus and subway, and means we actually burn less gas. Apparently we're going to add a new carbon tax on top of that, but that will also apply to natural gas and heating fuel...

Taxing gas also means that people have to think hard before buying gas guzzlers, and tend to right-size their car, if they buy a car at all.

Brad

This whole conversation ignores the fact the the bottom half of society is going to suffer economically. They will be less able afford a new car. And the gas savings will be significantly less than first assumed. And given that they live hand to mouth, future savings are often irrelevant. It often seems that lofty environmental goals are supposed to be achieved on the bakes of the poor.

I propose an alternative. Create a minimum fuel efficiency for a sedan. For example 20 mpg. In 2012 impose an additional federal 5% sales tax on the consumption of a vehicle that gets less than this minimum (this would be in addition to the state sales tax).

Each year after that, raise the tax by 10%. So 2013 would be 15%, 2014 would be 25% etc. Also raise the minimum fuel efficiency by 10% a year. So it would be 22 mpg in 2013 and 43 mpg in 2020 (which would have an additional sales tax of 85%).

This would only apply to new cars.

Next, take the revenue from these extra taxes and use them to subsidize r&d into fuel efficient and alternative fuel vehicles as well as infrastructure needed for new fuels (eg transmission lines or hydrogen production facilities etc). Because of the fact that a huge mass market would be created for environmentally friendly vehicles together with a subsidy for the r&d the poor would pay no more for such vehicles than they would have for a comparable car without this plan.

Finally continue raising this tax till 2030 where the extra sales tax would be 185% and where the new mgp minimum would be 111. This would make the affordable creation of alternative fuel vehicles inevitable. But again most importantly it would not strain the bottom 50% and only the very wealthy would pay such a tax (which even they could easily choose to avoid).

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D.S.

Another benefit, cars will be more marketable overseas where gas prices are much higher.

Marlene

I'm for anything that FORCES people to use public transportation.