Are Weaker Fuel Economy Standards Based on Faulty Logic?

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Wharton's Arthur van Benthem discusses his research on fuel economy standards.

During President Barack Obama’s administration, automakers were given a fuel efficiency target of 54.5 mpg for cars and light trucks by 2025. It was an ambitious policy, but one that the Environmental Protection Agency and the National Highway Traffic Safety Administration jointly determined was technically feasible and worth the costs. Under President Donald Trump, those same agencies are now challenging their own reporting, saying the costs of meeting such high fuel standards will far exceed the benefits. The current proposal would freeze the fuel economy standards at the 2020 level of 37 mpg.

But a new study is calling the administration’s bluff, contending that the reasoning behind the revised rule is unsound. Arthur van Benthem, Wharton professor of business economics and public policy, is one of 11 co-authors of the study, “Flawed Analyses of U.S. Auto Fuel Economy Standards,” which was recently published in the journal Science. “With the agencies currently in the process of determining whether the rule should be finalized, we describe how the 2018 analysis has fundamental flaws and inconsistencies, is at odds with basic economic theory and empirical studies, is misleading, and does not improve estimates of costs and benefits of fuel economy standards beyond those in the 2016 analysis,” the authors wrote.

Van Benthem joined the Knowledge@Wharton radio show on Sirius XM to discuss the research and offer context within the current political climate. (Listen to the podcast at the top of this page.) An edited transcript of the conversation follows.

Knowledge@Wharton: Weren’t these changes made with the goal of helping the auto industry?

Arthur van Benthem: That’s correct to some extent, and the automakers certainly have been asking to loosen the standards a little bit. Although what’s becoming increasingly clear is that the real effort in the background is being done by the oil industry, with recent reports coming out that companies like Marathon Oil and Exxon have been pushing pretty hard to reduce these standards.

Knowledge@Wharton: In terms of the reporting by the EPA and the Department of Transportation, where is their logic flawed?

Van Benthem: The EPA is arguing right now that if we loosen the standards — if we freeze them at the 2020 levels — it’s going to make new cars cheaper. There’s not as much need to install expensive fuel-saving technology, so more people will buy new cars. New cars have the latest safety features, so that basically leads to fewer accidents on the roads. Of course, that’s an extremely important benefit.

Now, here’s the elephant in the room. What you would expect if you loosened standards? More people buy cars. The fleet should become larger. But somehow — and this is a really important assumption in the current administration’s study — even though economic theory predicts that the overall (new and used) fleet size should grow, the EPA predicts that the total fleet of cars in the U.S., as a result of loosening standards, would shrink by about six million cars. And that runs counter to any basic economic logic.

Knowledge@Wharton: What do they base that estimate on? You would think lower costs would translate to people buying more cars.

Van Benthem: You would. This is Econ 101 that seems to be violated in the regulatory analysis, so this is quite puzzling.

We dove into these reports that came out. It’s actually pretty fun. It’s a 1,625-page document. It takes a while. It’s some light reading that’s been put together by hundreds of people, so it’s not the most beautifully written novel, as you can imagine. There are a lot of inconsistencies and assumptions on the market for cars. The way that the Department of Transportation models how the used fleet develops as a result of changing fuel economy in the new car market is sort of ad hoc and pieced together. The end result is that it’s an internally inconsistent fleet model.

“While the Trump administration is loosening the federal standards, states are tightening the belt elsewhere in the system.”

Knowledge@Wharton: The standards set by the Trump administration would get us to less than what the Obama administration was hoping for by 2020, correct?

Van Benthem: Indeed. I should add that whenever you read 55 mpg in the newspaper, it’s good to be aware this is regulatory miles per gallon. It’s based on these lab tests that are nowhere near actual fuel economy. So, the number to keep in your head is the original standard might have gotten us to about 36 mpg on-road, real-world fuel economy by 2025. And now the average new car may only get something like 30 mpg.

Knowledge@Wharton: What is the impact on the citizens, on our culture, on our environment by not reaching those standards set by the previous administration?

Van Benthem: I think society is going to lose money. In 2016, the previous administration had put together a similar analysis in which they looked at the proposal to tighten these standards all the way up to 2025. They found significant benefits to society. Sure, it costs a little more to install these technologies, but there are massive benefits of a smaller and cleaner fleet. So, fewer accidents. There are environmental benefits. Not just greenhouse gases, but also air pollution. By relaxing the standards, we’re throwing away all those benefits.

Knowledge@Wharton: What were the major differences between the 2016 report and the 2018 report?

Van Benthem: I would say that the error that we just talked about is a massive one. The way that the total car fleet is modeled is dramatically different. The other big difference is that the technology cost for meeting the standards in the new report is about twice as high as the technology estimate in the previous report. All of a sudden, in two years’ time, the Department of Transportation has become much more pessimistic on how cheap it will be to meet those standards.

Knowledge@Wharton: What about the impact on something like greenhouse gas emissions?

Van Benthem: That’s one of the key reasons that the previous administration had to impose these standards. Under the current analysis, because the prediction is that the fleet size will go down, we also see there’s a very limited impact on greenhouse gases. Now, we as a research team disagree with that in the sense that we don’t agree that the fleet size will shrink. Once you add back these six million missing cars, there’s actually a pretty sizeable increase in greenhouse gases.

Knowledge@Wharton: Will those missing cars be the newer vehicles coming on to the market or used cars? Because we’re also seeing a rise in the used car market, especially in the last few years.

Van Benthem: In this current analysis, it’s mostly going to be more used cars. There are missing used cars in the fleet. Not only are used cars less fuel efficient, but also in terms of local emissions of carbon monoxide and other local air pollution, older cars are disproportionately more polluting. That actually has a very, very big impact on the total environmental cost of the rollback. When you buy a new car, your fuel economy is fairly stable over its lifetime. But your local emissions exponentially grow as your car gets older.

Knowledge@Wharton: Can you talk more about the auto industry’s role in keeping the standards lower? Don’t they benefit from fuel credits as part of this process?

Van Benthem: Let me take a step back here and explain what these fuel credits are. There’s a reason we haven’t discussed why I think the current administration is a bit overly pessimistic on technology costs, and the reason is that the Department of Transportation’s analysis assumes that manufacturers can’t trade so-called compliance credits, even though in reality they can. What does that mean? Let’s say Ford has a very hard time meeting this standard, but Toyota is more able to — they can more cheaply produce these efficient cars. Toyota will generate some excess compliance credits that they can sell to Ford, and both companies will benefit from those trades.

“The car market is about a third of all U.S. greenhouse gas emissions, so this is not small stuff. This is a big deal.”

In the current analysis, the government is explicitly not considering such flexibilities. As a result, if you assume that every manufacturer needs to separately meet the standard for every car they sell, you’re going to find it’s much more expensive than reality in which firms can trade with one another. I think this is one of the reasons why the current report is extremely pessimistic, and more so than it should be, about the actual costs of those standards.

Knowledge@Wharton: This discussion is happening at a time when more automakers are investing in the technology to produce electric vehicles. How does that factor into this issue?

Van Benthem: There’s a very interesting interaction between the rollback of these standards and certain states that are moving in the opposite direction. Completely independently of the CAFE standards [Corporate Average Fuel Economy, first enacted in 1975], there are states like California that set more and more stringent targets. For example, a minimum percentage of electric vehicles need to be sold every year as a fraction of total new sales. While the Trump administration is loosening the federal standards, states are tightening the belt elsewhere in the system.

Knowledge@Wharton: There’s been talk about whether or not California is going to be allowed to keep those standards.

Van Benthem: The next year is going to be absolutely fascinating. We’re going to see California, probably followed by a bunch of other states, going to the federal courts and appeal not only the proposed rollback of the CAFE standards that we just talked about. The other, maybe even bigger issue is that the Environmental Protection Agency wants to revoke the waiver that California has historically had to set more stringent environmental policy for cars than the rest of the U.S. If the current administration succeeds in withdrawing that waiver, it means that California needs to get rid of its electric vehicle policy, which would be a massive shock to the system. This is going to be an absolutely fascinating thing to watch. And I’ll add that the car market is about a third of all U.S. greenhouse gas emissions, so this is not small stuff. This is a big deal.

Knowledge@Wharton: How important is the EV industry to California right now?

Van Benthem: It is very important, clearly. California is the state where most EVs are sold. It’s also a frontrunner; it tends to set national policy with a lag. The EV industry looks at California as the leader. Whatever they decide has major implications on the market.

Knowledge@Wharton: You also discuss in the report the assumption that the auto industry believes it would not have enough design time to continually update the standards that they would have to meet with their vehicles. It’s not necessarily the car itself, but it’s the technology and the systems within the car, so that you can continually hit the higher standards, correct?

Van Benthem: That’s correct. The current analysis that the administration has put together makes all kinds of assumptions on individual technologies. How much does it cost? What’s the lead time that’s needed to get it into the cars? I should add for full disclosure that while some of those assumptions are more pessimistic than two years ago, in some cases there is good evidence from academic studies that the previous analysis may indeed have been too optimistic. I think what we’re consistently seeing, though, is that the current proposal has moved every single assumption to about the most pessimistic end of the range. The question is, do we really believe this was a good-faith scientific effort? Or does it seem to be sort of playing with the numbers to get the conclusion you want?

“The current analysis that the administration has put together makes all kinds of assumptions on individual technologies.”

Knowledge@Wharton: You said something that I think is a question a lot of people have been wondering. It’s whether or not pulling back these standards was driven by the auto industry or oil industry?

Van Benthem:  Yeah, we can all speculate. I would put my money a little bit more on the oil industry than the car industry because some [auto] companies have already spent lots of time and resources on developing these electric cars. They already need to comply with more stringent standards internationally. They need to comply with the California standards nationally, so in some sense, they’re already on a pathway towards more aggressive fuel economy anyway. So, which industry stands to lose the most? Well, probably those who sell gasoline.

Knowledge@Wharton: Is this also a public relations move to downplay the electric and autonomous vehicle market in favor of the combustible engine market?

Van Benthem: Absolutely.

Knowledge@Wharton: Would the estimate of six million fewer vehicles rely on the assumption that there will be decrease in drivers as baby boomers age and the younger Generation Z favors public transportation?

Van Benthem: That’s a good point, although I would say two things to that. First, there may be all kinds of other reasons why the fleet expands or shrinks. But that’s orthogonal to the question that we’re talking about here, which is: What is the effect of those standards? But you’re right that there could be all kinds of other demographic trends. A lot of people would think that with more people moving to cities, you would see a decline in car ownership because of changes in norms and culture. It’s not quite as clear. There may be a little bit of an effect, but I don’t think it’s realistic to assume that, all of a sudden, we’ll be biking and buying our organic groceries all the time.

Knowledge@Wharton: If you’re talking about a loss of six million vehicles, even if a majority of that is on the used car market, that’s going to have a significant negative impact on the auto industry. Then that rolls that cycle forward, where it’s not only a problem for the auto industry, it is then a problem for the oil industry.

Van Benthem: That’s right. I think from the perspective of oil companies, what determines their long-term growth of gasoline sales in the U.S. is whatever the government decides on CAFE standards. That’s probably the No. 1 most important risk, if you will, even relative to all these other trends that you mentioned.

Knowledge@Wharton: What do you expect will play out over the next year or two with California?

Van Benthem: You should ask the environmental law experts in Wharton’s legal studies department. My reading of this is that there’s good reason to believe that there is precedent for the California waiver. A number of experts I talk to think it would be very strange, and counter to previous decisions, to deny California the waiver. That said, with the increasingly politicized courts, I find it very hard to predict. I think the California Air Resources Board is close to being at war with the federal EPA. And if nothing else, it’ll be an interesting, and almost entertaining fight to watch over the next 12 months.

Knowledge@Wharton: Where does the auto industry stand in this fight right now?

Van Benthem: I think the automakers certainly thought that the old standards were being extremely aggressive, and they would have a hard time meeting them. It would be pretty expensive. But they never asked for a complete freeze. They were just asking for a little bit of a reduction. Because they also know that if they have to comply with stringent rules in other countries and other states, it’s a pathway that’s already being started. I don’t believe the automakers would mind it very much if the final outcome is going to be a compromise in which it’s not going to be a freeze but let’s say, as usual in politics, we end up somewhere in the middle. So, it will keep rising, but maybe not quite as fast.

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Are Weaker Fuel Economy Standards Based on Faulty Logic?. Knowledge@Wharton (2019, February 05). Retrieved from https://knowledge.wharton.upenn.edu/article/are-weaker-fuel-efficiency-standards-based-on-faulty-logic/

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