Markets, Not Mandates, Best Way to Set Fuel Efficiency Standards


Evidence from America's 23-year experience with auto fuel efficiency standards tells us that government-mandated fuel efficiency leads to increased highway fatalities, the disruption and costly restructuring of major industries, the introduction of larger, less fuel efficient vehicles, and quite possibly the consumption of more, not less, gasoline, and therefore the creation of more pollution. For those who value human life and environmental quality more than barrels of oil, fuel efficiency standards are a poor but costly substitute for regulation by market forces. A quick review of the fuel efficiency saga will explain why markets need to be strengthened and regulation of fuel efficiency needs to become history.

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The Birth and Rebirth of CAFE

When the average price of gasoline nationwide jumped to $1.75 per gallon in May—the highest in a decade—family budgets were strained and the sale of seemingly ever-popular sport utility vehicles (SUVs) sagged. Gasoline prices had been rising since January 1999, so it didn't take rocket science to predict how managers in Detroit and other auto production centers would respond. Plans to introduce smaller, more efficient SUVs were accelerated.

Though muzzled by federal regulations, the market spoke clearly. Gasoline is getting scarcer. Now is the time to economize.

While consumers altered their gasoline consumption habits, and producers scrambled to provide more fuel efficient cars, savvy Washington politicians saw rising gasoline prices as an opportunity to fan the flames of a smoldering energy crisis and reopen debate on the Corporate Average Fuel Efficiency (CAFE) standards.

First set in place in 1975 in the wake of the 1973 oil embargo, CAFE set the average fuel economy to be attained for each producer's fleet at 18 mpg in 1978. The political majority didn't trust the market. CAFE standards for cars rose to 27.5 mpg for model year 1985, where the standard still rests. The standards for light trucks and SUVs were first set in 1979 at 17.2 mpg for two-wheel drive vehicles and 15.8 mpg for four-wheel drives. This part of CAFE now rests at 20.7 mpg and 19.1, respectively. It is the level and the difference between the auto and SUV standards that fuels the current political debate.

Because of differences in the standards for cars and SUVs, Americans who choose to drive large SUVs have become the target of nanny-like nagging from self-appointed keepers of energy morality. These, along with some concerned environmentalists, also point to the possible linkage between fuel consumption, carbon emissions, and global warming. Concern about dependency on Arab oil, which was the principal argument used in 1975 to support CAFE, is no longer the top political motivator.

Another Bootlegger-Baptist Opportunity

With special interest support for tougher CAFE standards coming out of the political woodwork, politicians can easily see the makings of another Bootlegger-Baptist opportunity. Only this time, the struggle does not involve devout Baptists fighting for Sunday closing laws that shut down the legitimate sellers of booze, and coincidentally opens the market for clever bootleggers who gladly contribute to political campaign funds. Instead, outspoken environmentalists and populists support the tighter CAFE standards while auto producers without successful SUV products and foreign producers with plenty of fuel efficiency to spare can quietly celebrate an opportunity to raise their competitor's costs.

Since 1985, any dramatic change in the price of gasoline, up or down, has led to calls for revisions in the standards. Price did fluctuate, but between 1981 and 1999, the price of gasoline adjusted for inflation fell more than 60 percent. Along the way, manufacturers responded successfully to a challenging mix of consumer and regulatory demands that called for larger and more efficient vehicles. Between 1980 and 1998, the fuel cost per-mile-traveled for passenger cars, stated in constant 2001 dollars, fell from 16.3 cents to 5.6 cents. In the same period, the same cost for SUVs and pickup trucks fell from 21.4 cents to 7.4 cents.

What Hath CAFE Wrought?

The experience with CAFE has been filled with troublesome controversy. CAFE is now associated with excessive traffic deaths, increased market penetration by foreign nameplates, and oddly enough, the blossoming of the much maligned SUV market.

When first proposed, government witnesses predicted that limitation on fuel consumption would be met initially by vehicle weight reductions. Given the laws of physics, which could not be repealed, fatalities would rise in collisions involving lighter vehicles that would flow inevitably from the standards. Passage of CAFE into law meant trading human life for barrels of oil.

In 1989, with enough evidence in hand to examine the issue, academic economists estimated that CAFE was indirectly associated with 2,200 to 3,900 excess fatalities per year. As the mix of vehicles has changed, these effects have likely changed as well. Indeed, the fatality effect may have been reduced since CAFE-induced trucks represent half of new vehicles sold.

When U.S. producers set out to downsize their fleets in the late 1970s they chopped the upper end of product lines. But markets will work. Foreign producers who grew larger cars out of smaller ones met part of consumer demand for larger, and safer, vehicles. While cars by Honda, Toyota, and Nissan grew larger-and on average consumed more fuel, cars with the Big Three nameplates got smaller and consumed less gasoline. Ultimately, domestic producers who introduced pickup trucks and four-wheel drive vehicles with more luxury and space met unsatisfied consumer demand for larger vehicles. The SUV market blossomed because of CAFE.

Finally, to the extent that CAFE standards really delivered smaller, more fuel efficient cars, it is clearly possible that consumers reacted by buying more cars per household than they would have otherwise. After all, more cars can substitute for larger cars. The growth of the multi-car family and extent of this so-called rebound effect blunts the intended efficiency effects of CAFE. More miles driven in smaller cars can lead to more, not less, gasoline consumed, and to more, not less, environmental damage.

Letting Markets Regulate

Congress is once again considering how to revise CAFE to make fuel efficiency regulation more effective. Some interest groups offer passionate as well as dispassionate support for a tougher CAFE. Others seek to maintain the status quo. There is no special interest group that supports elimination of CAFE and enhancement of market forces.

The 23-year experience with CAFE tells us there must be a better way to conserve energy, promote efficiency, and expand consumer choice. This, of course, is what free markets do best. The current round of CAFE hearings should be about how to unleash markets, not how to impose more regulation.

It is time to make CAFE a part of U.S. regulatory history.

"The 23-year experience with CAFE tells us there must be a better way to conserve energy, promote efficiency, and expand consumer choice. This, of course, is what free markets do best."