Another Victory for Regulatory Reform: Fuel Economy Standards by David Montgomery

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On August 2, the Department of Transportation (DOT) and Environmental Protection Administration (EPA) announced revised fuel economy standards for passenger cars and light trucks to be applied in model years 2021 – 2026. The revised standards would replace standards set by the same two agencies in 2012, well before the revolution in oil drilling technology that has moved the U.S. to the top of the list of oil producing countries and caused gasoline prices to fall dramatically.  

The law that authorized setting the 2012 standards also provided for a mid-term review, so that changes that might occur in the eight years between the publication and effective dates of the original rules could be taken into account.  The result of the review, announced on August 2, is that standards will be frozen at 2020 levels through 2025.

To clear up a potential misunderstanding, DOT sets fuel economy standards and EPA sets greenhouse gas emission standards.  But since the two are in practice two ways of measuring exactly the same thing, the two agencies have agreed to harmonize and publish their regulations in a single rule-making.

The proposed standards are good news for car buyers, U.S. industry and the economy.  They are good news for new car buyers because they will slow the rate of increase in new car prices and allow buyers greater freedom to choose among gasoline consumption, performance and amenities.  

They will also make new cars safer.

The proposed standards are good for U.S. industry because they will avoid the shrinkage of new car sales that these adverse consumer impacts would cause.  

They are good for the economy because on balance the reduction in traffic fatalities, moderation of regulatory distortions to consumer and manufacturer decisions, and lower new car costs more than offset higher gasoline expenditures and modest increases in emissions.

All these points are made and supported logically and quantitatively by an exceptional Preliminary Regulatory Impact Analysis (PRIA) that was released at the same time as the new standards.   It incorporates sound reasoning, transparent assumptions and sophisticated economic analysis. It addresses issues such as unintentional consequences and hidden costs that were glossed over in prior rule-makings, and it corrects arbitrary and indefensible decisions such as those affecting the value assigned to greenhouse gas reductions.

The fuel economy standards set by the Obama Administration have been particularly contentious, though the flaws in the entire regulatory system have been pointed out (by me among others) from its very inception.

There is strong evidence that federal standards did little or nothing to increase overall fuel economy once oil prices increased rapidly from the late 1970s onward.  These oil price increases made it in the interest of consumers to choose at least as much fuel economy improvement as the standards dictated.

That is not to say that prior fuel economy standards did not distort the market or impose costs.  The original law mandating the standards created several arbitrary classes of vehicles with different standards: imported versus domestic, passenger car vs light truck, and light vs medium truck being the most important.  This led to a seismic change in the automobile market when sport utility vehicles and mini-vans classified as trucks but functioning as passenger cars were introduced to take advantage of the less-stringent standard for trucks.  In addition, the original rules did not allow manufacturers to trade allowances, so that competitive impacts were exaggerated and total costs to buyers increased.

Passage of the dreadful Energy Independence and Security Act of 2007 and President Bush’s even more unfortunate opening of the door to EPA regulation of greenhouse gas emissions set up the opportunity for the Obama Administration to impose standards for fuel economy substantially different from market demand.  Binding standards also create a number of distortions in consumer behavior: switching to smaller and lighter weight vehicles that increase accident severity, increasing smog-producing emissions by driving more because fuel cost per mile is lower, and keeping older gas guzzlers on the road because of increases in new car prices.

It is very gratifying to see that EPA and DOT have recognized all these issues, and have attempted to work within the imperfect regulatory framework dictated by Congress to minimize regulatory distortions and maximize safety.

The original standards would have progressively required greater and greater improvements in fuel economy from 2020 to 2025.  There are three very good reasons why these standards needed to be changed.

Since 2012, the world oil market has been turned upside down by the fracking revolution in the United States, which turned the charts for future gasoline prices from sharp upward trends to flat forecasts.   In January U.S. oil production exceeded 10 million barrels per day for the first time since 1970, and put the U.S. third in the world in total production. This dramatic change completely undercuts the belief that fuel economy standards are necessary to protect consumers from rising prices that they did not foresee when they purchased new cars.  It also substantially reduces concerns about oil price shocks, as confirmed in an independent, scholarly study done by Resources for the Future last year.

Second, more careful analysis laid out in the PRIA reveals that technological opportunities for further improvements in fuel economy are limited, so that manufacturers are likely to have to resort to reducing the weight of even the smallest and most efficient vehicles to achieve sufficient gains.  This then increases the risk of fatalities in traffic accidents, so that continuing to tighten standards would be likely to lead to more traffic deaths.

Finally, the PRIA finds that the expectations of technology improvements that were relied on to set the original standards have turned out to be overly-optimistic.  The study discusses exhaustively how the technology assumptions justifying the old standards turned out to be incorrect. In some cases, it was because the writers of the Obama rule did not realize how extensively some technologies were already in use, and so double-counted the benefits. In others, they anticipated adoption of new technologies which did not appear or which encountered such strong consumer resistance that they were pulled back.  More generally, many technologies can be used to improve fuel economy, or performance, or allow more amenities to be added. Manufacturers have followed consumer preferences by supplying a mix of all three. As the RIA perceptively states, sacrificing such amenities or performance to achieve tighter standards is a hidden consumer cost.

How the RIA values damages from greenhouse gas emissions is also important. The Obama Administration justified tightening fuel economy standards to reduce greenhouse gas emissions by estimating the total global damages that would be avoided.  Despite telling criticisms of the analysis done to estimate the social cost of carbon dioxide emissions, the PRIA made only the abundantly sensible change to include only damages estimated for the United States. That, it turns out, makes a significant difference in the comparison of costs incurred in the U.S. to the benefits included in the analysis.  

Putting all this together, the PRIA rolls out 1500 pages of documentation of its calculations of costs and benefits and concludes that the alternative chosen – freezing the standards at 2020 levels – provides greater social benefits, greater consumer satisfaction, and lower fatalities than any of the more stringent alternatives.

Despite the quality of the analysis and sensibility of the new standards, the debate will not be settled soon.  Some economists have become convinced through behavioral studies that consumers consistently make mistakes in buying new cars, and later regret not buying cars with better fuel economy.  Whether this particular form of buyers’ remorse constitutes a market failure that justifies the nanny state telling consumers what to do is another question.

A more challenging problem is that California now sets its own fuel economy standards that are adopted by 17 other states, and the standards set in the Obama Administration were chosen to match those increasingly ambitious state standards.  The new proposal would, if nothing were done about the state standards, create one standard for 32 states and another for 18. Some manufacturers, led by GM, are adamant that there must be a single 50-state standard, and the 18 states have already announced their intention to look for a judge to overturn the new standards.  

There is a simple solution to GM’s problem, because California must receive a waiver from EPA to set its own standards.  The criterion is that California’s standards must protect public health and welfare at least as strictly as federal law, and their standards must be necessary “to meet compelling and extraordinary conditions.”  Waivers to allow California to solve its unique smog problem made sense.

But greenhouse gas emission standards – which are the same as fuel economy standards – are not the same.  Greenhouse gas emissions originating from cars sold in California are dispersed globally and have only a negligible effect, if any, on California. Since GHG emissions are global in their effect, none of the geographic and demographic conditions that give California an extraordinary problem with smog apply to greenhouse gases.  That makes the waiver that allows California to set its own fuel economy standards a mistake in the first place, and the logical next step for the Administration should be to rescind the waiver.

That, in addition to the perennial disagreements about the need for any fuel economy standards, would make things very interesting.  Stay tuned.

David Montgomery is retired from a career of teaching, government service and consulting, during which he became internationally recognized as an expert on energy, environmental and climate policy.  He has a PhD in economics from Harvard University and also studied economics at Cambridge University and theology at the Catholic University of America,   David and his wife Esther live in St Michaels, and he now spends his time in front of the computer writing about economic, political and religious topics and the rest of the day outdoors engaged in politically incorrect activities.

 

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Letters to Editor

  1. Norm Dulak says:

    This article is nonsense. As would be expected, the current administration continues to bend over backward to serve industry, no matter what the cost to health and the environment. So we are to believe that because greenhouse gas emissions are a global problem, California and other concerned states should do nothing to improve the situation. But fortunately, much of the rest of the world understands the problem and is moving to reduce fuel consumption and vehicle emissions. In many places internal combustion vehicles will be eliminated. In others, emission standards will substantially improve. And if the proposed reduced standards are implemented for the U.S., Detroit products will not be on my shopping list for my next automobile.

  2. Briggs Cunningham says:

    Please, someone please ask this author to stop spouting nonsense. “smaller and lighter weight vehicles” DO NOT “increase accident severity”… vehicle speed and mass DOES. “smog-producing emissions” DO NOT increase if “fuel cost per mile is lower,” but they DO with lots of less-efficient vehicles; and, “keeping older gas guzzlers on the road” DOES NOT occur “because of increases in new car prices,” but idiotic policies that don’t improve fuel efficiency WILL keep guzzlers on the road.

    • David Montgomery says:

      I try to keep these columns short, but this time I must have shortened the safety discussion too much. It is the difference in mass that matters in a vehicle to vehicle collision, with the lighter vehicle suffering more damage the bigger the difference. Think deer vs Mini compared to deer vs Hummer. The Obama RIA claimed that with tight standards, auto manufacturers would have to reduce the weight of their heaviest vehicles. The new PRIA contests that finding, arguing that observing manufacturers behavior and technology development since 2012 makes more likely that the tighter standards will cause manufacturers to reduce the weight of the smallest vehicles more.

  3. Gas has gotten cheaper? Not in my neck of the woods. Since the rest of the world has embraced the idea of climate change and has responded with transportation ideas that offer an educated response to counteract the effects of a changing climate, will America ever be able to export any of the vehicles manufactured here in America?

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