July 1, 2008

Average Fuel Economy Standards, Passenger Cars and Light Trucks; Model Years 2011-2015 (CAFE)

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The Regulation

The Department of Transportation has proposed a new rule that would significantly increase the national corporate average fuel economy standards (CAFE standards) in years 2011 – 2015.  The proposed rule is intended to force the fuel economy in the US towards a fleet-wide average of 35 miles per gallon or better by the year 2020.

Our Findings

The proposed changes in the CAFE standard could have the unintended consequence of induced technological lock-in.  Significant fixed cost investments in vehicle manufacturing facilities would likely need to occur immediately in order for vehicle manufacturers to be compliant by the year 2011.  This might force manufacturers to largely embrace the gasoline-electric hybrid vehicle, despite growing evidence that in the long run either a fully electric vehicle or a fuel cell vehicle would be an inherently superior technology. 

The proposed rule could delay investment in alternative fuel vehicle technologies, locking the industry into the gasoline-electric hybrid technology at the expense of investment in other alternative fuel vehicle technology.

Consumers appear to be already shifting to a mix of vehicles with much higher fuel economies than DOT assumes in its analysis.  If gasoline remains relatively expensive and environmental awareness continues growing, consumers’ valuation of fuel economy will likely correspondingly increase.  This increase in average fuel economy should not be attributed to the proposed rule.  This is not to say the proposed rule is costless: the proposed rule would result in less choice for consumers who might need specialized vehicles, such as those with large towing capacities, and delay development of alternative fuel vehicles. 

As fuel economy increases, the cost of driving one mile decreases, and consumers will therefore drive more.  The benefit-cost analysis presented in the proposed rule does not appear to appropriately consider the increasing marginal cost of congestion that could result from increased driving.

Our Recommendations

To reduce the chances of inducing technological lock-in, DOT should delay the largest increases in the CAFE standard until after 2015.  Vehicle manufacturers, knowing that the CAFE standard will be 35 mpg in 2020, could then choose to invest in alternative fuel vehicles or choose to increase production of gasoline-electric hybrid vehicles.  Delaying the increases in the CAFE standards will allow the best possible long run technology to prevail in the market.

There are many ways DOT could avoid inducing technological lock-in while simultaneously encouraging manufacturers to increase fuel economy.  These include:

Creating a system in which vehicle models that exceed CAFE standards bear a “CAFE compliant” emblem similar to the Energy Star program for electronics and household appliances.  Consumers who value fuel economy most would seek out those models with such emblems, matching those manufacturers who produce high fuel economy vehicles with consumers who desire a visible confirmation of high fuel economy.

Allowing an alternative fuel vehicle technology investment grace period.  Manufacturers could demonstrate to DOT that rather than comply with an increased CAFE standard, they instead invested the amount compliance would have cost in developing alternative fuel vehicle technology.