Fuel Economy Standards: Would a Freeze Impact Innovation?

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Wharton's Sarah Light and John Paul MacDuffie discuss a proposal to freeze U.S. fuel efficiency standards.

The Trump administration wants to freeze fuel-efficiency standards for cars and light trucks at 37 mpg, a move that would reverse an Obama-era policy calling on automakers to hit an efficiency target of 54.5 mpg by 2025. The proposal also would prohibit states such as California from setting their own emissions standards.

Automakers support the potential change, citing the difficulty of building to different emissions specifications and the high cost of developing more fuel-efficient vehicles. But environmental and consumer advocates contend better fuel efficiency is needed to slow climate change. They also dismiss the U.S. Department of Transportation’s logic that holding the line on fuel efficiency could save lives and improve safety on the roads. The agency said lowering the cost of new vehicles would encourage Americans to trade in their older cars for newer rides that have up-to-date safety technology.

The Knowledge@Wharton radio show, which airs on Wharton Business Radio on SiriusXM, invited two Wharton professors to explain the potential change and how it could play out across the political and business landscape. John Paul MacDuffie is a management professor and director of the Program on Vehicle and Mobility Innovation with the Mack Institute for Innovation Management. Sarah Light is a professor of legal studies and business ethics. The following are key points from their conversation.

Remember, It’s Just a Proposal

The announcement from the White House came across to many as yet another controversial decision from a president intent on rolling back regulations he sees as unfriendly to business. But Light pointed out that the proposal has a long way to go before reaching its final destination. And there’s no telling how it may be altered along the way.

When federal agencies issue a proposal, it is published in the Federal Register and made available for public comment for at least 30 days. The agency is required to take the comments into account before issuing a final version of the rule, Light said.

“Sometimes, I think the headline is, ‘Trump administration is weakening the standards,’” she said. “The more accurate headline is, ‘Trump administration is proposing to weaken the standards,’ so it’s not clear whether the rule that’s been proposed as of August 2 is going to be what the final rule actually looks like.”

Light believes the proposal is in for a protracted legal battle, especially over state emissions. California’s attorney general has already said the state will sue the federal government over any attempt to revoke its right to set tougher standards.

Providing some historical context, Light explained why California is uniquely positioned in this fight. California had already been regulating emissions for years by the time the Clean Air Act went into effect. That’s why the federal government gave the state special authority to apply for a waiver from the EPA if it could show that its standards were at least as protective of human health as federal standards. It also had to show that independent standards were needed to address conditions particular to the state.

“As we know, California has extreme levels of air pollution that don’t exist in other parts of the country,” Light said. California has requested waivers more than 50 times; each request has been granted.

“One of the big questions here is, what is the incentive for the auto companies to keep working away at fuel efficiency in the absence of a very ambitious goal?” –John Paul MacDuffie

“There has never been a revocation,” Light said. “If you look at the text of the Clean Air Act, it is not authorized by the text, so I think to revoke California’s waiver would be a serious uphill legal battle for the federal government.”

Automakers Likely Will Proceed with Caution

How this proposal could impact automakers depends largely on how they decide to respond to it, MacDuffie said.

“They are being cautious,” he said. Automakers prepare vehicle models eight to 10 years ahead of release, so they don’t necessarily want regulatory changes that would force them to overhaul product development.

“They don’t want to give up all the advanced technology initiatives they’ve been doing,” MacDuffie said. “They wouldn’t mind a slightly more relaxed pace, and they absolutely don’t want to set the standards.”

California’s independent emissions standard is now followed by 13 other states, which complicates the issue. Automakers tend to overshoot the federal target in order to comply with California and avoid manufacturing to different standards.

“One of the big questions here is, what is the incentive for the auto companies to keep working away at fuel efficiency in the absence of a very ambitious goal?” MacDuffie said. “This isn’t just about making smaller cars or lighter cars or electric vehicles or hybrid vehicles. It’s about a lot of innovations to the internal combustion engine to make it more fuel efficient. It’s the reason that it’s very hard to buy a V8 in anything. A lot of the cars that had a V6 in the past now have a turbo-charged four-cylinder [engine]. There’s a vast amount of innovation in internal combustion engines to help these goals, and it might not continue at that pace. It’s expensive, but it’s advancing goals that are [advantageous] to the consumer in terms of lower gas prices and to the broader environmental goals.”

MacDuffie also pointed out that when it comes to technology, there is a general view that the government should not pick sides or favor one type of innovation over another. But favoritism happens. When standards were relaxed during the Reagan years, for example, fewer patents were filed.

“This seems to be an industry that has dragged its feet on safety technology and environmental technology,” he said. “To have a bit of forcing pressure — not to one specific technical fix but to a technical goal — has actually been very valuable for getting innovation.”

“If you think of electric vehicles as new technology that’s threatening the internal combustion engine, I think we’re very much in the glory period of the last gasp of innovation.”–John Paul MacDuffie

Was Obama Too Ambitious?

The proposed change raises the question of whether the 54-mpg target set by the Obama administration was too ambitious for automakers to hit. According to the professors, the short answer is “no.”

First, the automakers negotiated with the federal government and agreed to the higher efficiency standard. Second, the Obama-era agreement offers credits and other devices to allow some flexibility in meeting the 54-mpg target. For example, makers of electric vehicles can sell their credits to manufacturers of traditional vehicles. Tesla has made quite a lot of money doing just that.

The bottom line, MacDuffie said, is that automakers have never liked federal regulations.

“They don’t want to come out and publicly oppose the president, and they don’t really want to say that they love the regulations because, at a base level, they don’t,” he said. “But if you read between the lines, they’re saying, ‘We said we wanted flexibility, but we didn’t want to throw out the whole old structure because that’s very destabilizing for us.’”

MacDuffie cited a well-documented phenomenon that researchers have dubbed “the last gasp,” where an incumbent technology goes through a tremendous burst of innovation when threatened with obsolescence.

“If you think of electric vehicles as new technology that’s threatening the internal combustion engine, I think we’re very much in the glory period of the last gasp of innovation,” he said.

In recent years, the auto industry has surprised even itself with how much more efficiency it’s been able to squeeze out of vehicles.

“To me, that kind of innovation is exhilarating and what we ought to see coming out of our auto industry,” MacDuffie said. “It might force making more very small, very fuel-efficient cars that nobody wants to buy because they’re too small and too uncomfortable. But consistent with this theme that a little push toward an ambitious technical goal is good, I think we’re seeing the fruits of that right now.”

Light also doesn’t buy the current administration’s argument that the Obama-era policy was an overreach, especially because automakers have been able to hit the higher standards set by California.

“I think that the global influence, even if it doesn’t happen immediately, is certainly going to play a big role here.”–Sarah Light

“They’re not having any trouble meeting the technology requirements, so I think that’s really a bit of a red herring as well,” she said.

Don’t Discount International Peer Pressure

The professors warn against taking a myopic view on fuel efficiency. If the United States relaxes its standards, it may find itself at a disadvantage in the global marketplace.

China is positioning itself as the biggest electric vehicle market in the world, with an aggressive government policy to invest in the charging infrastructure and to encourage domestic and foreign firms to make electric cars. Easing U.S. standards on fuel efficiency wouldn’t stop American automakers from developing electric cars, MacDuffie said, but it might put them behind their European and Asian competitors.

“It raises the question of why we want them to back off the pace if we think these are important technologies for the industry in the future, not just in the U.S. but worldwide?” he said. “That’s leaving aside the climate change benefits — which get debated in a broad ideological sense, but I think it’s very clear cars are the No. 1 source of greenhouse gases in the world now.”

Light agreed, calling the global market a significant piece of the puzzle. When one country enforces more stringent regulations, other countries tend to follow suit.

“I think that the global influence, even if it doesn’t happen immediately, is certainly going to play a big role here,” she said. “When you’re dealing with global, multinational firms that play in a lot of different sandboxes, they have to comply with laws passed by other jurisdictions, and that really changes the game. You can’t look with blinders on to what’s going on outside the United States.”

The Decision Will Not Be Simple — or Quick

Like many of the proposed changes coming from the Trump administration, the public will just have to wait and see whether this one takes effect. Given the uphill legal battle, pressure from environmental groups, and an ambivalent auto sector, nothing is a foregone conclusion.

“Another way to think about this is a negotiation strategy — an effort by the administration to get California to negotiate with it for a single standard.”–Sarah Light

Light reiterated that what was negotiated in 2012 had buy-in from all stakeholders, so perhaps this move is designed to get California to come back to the bargaining table.

“Another way to think about this is a negotiation strategy — an effort by the administration to get California to negotiate with it for a single standard,” she said. “It’s not clear that’s really going to work in this environment.”

MacDuffie also said the outcome is unclear. “At one level, you see this as another effort to reverse one of the key policies of the Obama era and to just have a big headline which says we’re getting rid of regulations,” he noted. “But some of these fuel regulations have a history that goes to the 1970s, to the Clean Air Act, to bipartisan support from Republican and Democratic presidents and Congresses, so I think there’s not a huge appetite for this change in the auto industry. I think it will be interesting to see what they will do.”

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Fuel Economy Standards: Would a Freeze Impact Innovation?. Knowledge@Wharton (2018, August 10). Retrieved from http://knowledge.wharton.upenn.edu/article/gas-mileage-standards-change-will-impact-drivers-automakers/

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accessed December 19, 2018. http://knowledge.wharton.upenn.edu/article/gas-mileage-standards-change-will-impact-drivers-automakers/


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