Wharton’s John Paul MacDuffie and Eric Orts discuss why automakers are pushing for uniform fuel efficiency and emissions standards in the U.S.

Auto companies in the U.S. have long product planning cycles and therefore want uniform and predictable regulations on fuel efficiency and emissions standards. Currently, 14 states and the District of Columbia, led by California, have higher emissions standards than the rest of the country. The automakers also recognize that even as 98% of the cars sold worldwide run on fossil fuels, a secular shift to electric cars is inevitable; it is already moving ahead in China and Europe. Yet they continue innovation on internal combustion engines to make them more climate-friendly before they are retired. That is because only sales of those cars will fund investments in new technologies such as electric cars.

With that as the context, last week 17 automakers urged President Trump to support one progressive, national standard for fuel economy and greenhouse gas emissions standards, especially by bringing California on board. In their letter to Trump, they said a negotiated deal with California was important to prevent lengthy instability and litigation. The same day, the automakers sent a similar letter to California Gov. Gavin Newsom, urging him to find a compromise.

As the new standards are likely to be finalized this summer, U.S. automakers want regulations to get stronger each year to accommodate new technologies that offer lower emissions. “We support a unified standard that both achieves year-over-year improvements in fuel economy and facilitates the adoption of vehicles with alternative power trains,” they stated in their letter to Trump.

Time to Speak Up

The auto companies now seem to realize that going public with their regulatory wish list is important to facilitate uniform emissions standards, according to Wharton management professor John Paul MacDuffie, who is also director of the Program on Vehicle and Mobility Innovation at Wharton’s Mack Institute for Innovation Management. MacDuffie recalled that the automakers “didn’t say much” last year when the EPA sought to review the standards set by the Obama administration. “I think their sense was, if the regulations could be relaxed a little bit, that would make life easier for them,” he said. “Before, they didn’t want to take a public stand, [but] now they’ve been forced to – maybe too little, too late.”

In pushing for California to join a single standard, the automakers asked Newsom to find a “midway between the existing standards and the preferred path outlined in the recent Environmental Protection Agency proposal.”  The final rule should include annual reductions in permissible emissions and “flexibilities to promote advanced technology for the sake of long-term environmental gains,” they said.

“Before, [automakers] didn’t want to take a public stand, [but] now they’ve been forced to – maybe too little, too late.” –John Paul MacDuffie

The “midway” that the automakers are advocating is essentially a compromise between the standards the Obama administration instituted in August 2012 and the Trump administration’s desire to undo that. The Obama-era standards required automakers to increase the fuel efficiency of cars and light-duty trucks to 46.7 miles per gallon by model year 2025 (revised from the original goal of 54.5 mpg) from the prevailing levels of 35 mpg. However, in August 2018, the EPA and the National Highway Traffic Safety Administration (NHTSA) sought to freeze those fuel efficiency norms at the existing levels for six years, covering model years 2020 through 2026.

The EPA proposal also sought to withdraw a waiver from the Clean Air Act that California had secured in the 1960s, which allowed it to set its own emissions standards. Now faced with revocation of that waiver, the State of California last Friday sued the Trump administration for details of its plan to lower the standards on tailpipe emissions for cars and trucks.

The Trump administration has “a very weak case” in its attempt to strip California of its right to set its own emissions standards, according to Eric W. Orts, Wharton professor of legal studies and business ethics, who is also director of Wharton’s Initiative for Global Environmental Leadership. “The record so far of the Trump administration [in environmental protection] is abysmal,” he said. “They don’t come prepared with any facts,” unlike the “scientific basis” that went into the setting of the standards by Obama administration, he added. Those strict emissions standards were “good for overall health,” and the broader economy will benefit from lower costs associated with fuel efficiency, he noted.

MacDuffie and Orts discussed the automakers’ recent moves on emissions standards on the Knowledge at Wharton radio show on SiriusXM. (Listen to the podcast at the top of this page.)

Investment Dilemma

Regulatory certainty is critical for automakers. “The auto industry is a slow clock-speed industry and has a super long product life cycle of four to six years,” said MacDuffie. “Nothing is more expensive than disrupting that in the middle. A fundamental business interest for them is stability in these rules.”

They also face “huge dilemmas” in planning their investments, said MacDuffie. “They’ve got to keep the existing business going because that [accounts for] 98% of their sales, but they’ve got to invest in the new technologies because they know they are coming. That is the investment dilemma for them, and that’s why they don’t need more disruption like two standards for their fuel emissions and efficiency standards in the U.S.”

MacDuffie noted that U.S. automakers have invested heavily in innovation to produce vehicles with lower emissions, such as electric vehicles and hybrid vehicles. But they are also investing in improving the fossil fuel-driven internal combustion engines that are on their way out. He described that as “a last-gasp phenomenon, where an incumbent technology that’s threatened has a sudden spurt of innovation as it is about to disappear.”

“We will look back on the internal combustion engine like we look back on horses and buggies, which were also dirty in the streets.” –Eric Orts

Innovation in internal combustion engines is significant because cars using that technology will not disappear in a hurry. Cars last 10 to 15 years, including their life in the used car markets, said MacDuffie. Of the nearly 100 million cars sold worldwide last year, barely 2% were electric, and it would take a long time before electric vehicles replaced those powered by internal combustion engines, he noted.

The California Factor

In their quest for regulatory certainty to protect their investments, automakers also want to avoid long, drawn out legal tussles as California resists attempts to remove its special status. California won the right to set its own emissions standards in the 1960s when Los Angeles was battling high smog levels caused by vehicular traffic, MacDuffie recalled. While that smog issue was subsequently resolved, California retained its control on emissions standards, despite several legal challenges.

If vehicle emissions standards are implemented uniformly nationwide, California will not be the only state that will be forced to rewrite its rules. Orts pointed out that 13 states and the District of Columbia have adopted California’s emissions standards. “So, this is a big market, and it’s not a question of just carving out California,” he said, noting that the Golden State alone accounts for one-fifth of the U.S. economy.

Those standards have also instilled in Californians a respect for environmental protection, Orts noted. California has over the years developed a unique “car culture” that has an emphasis on clean air, he said. That is one reason the state has a high population of electric vehicles with zero emissions, he added.

Preparing for the Electric Era

In their letter to President Trump, the automakers noted that consumers are encouraged by lower fuel prices to buy more fuel-guzzling SUVs and pickups, and that the shift to alternative power trains like electric has been slower than anticipated. “They see from the evidence of their showroom traffic that people aren’t necessarily gravitating towards the most fuel-efficient vehicles,” said MacDuffie.

The mounting concern over greenhouse gas emissions would inevitably force automakers to switch to electric cars or those powered by renewable fuels, said Orts. “That is why Tesla has relatively high valuations even though it has lots of problems,” he added. “In the long term, electric is probably a significant part of the answer.” He noted that batteries are getting increasingly better and cheaper, and more renewable energy is available at lower costs.

A big switch to electric cars is inevitable “if you’re going to control for environmental problems,” Orts said. “We will look back on the internal combustion engine like we look back on horses and buggies, which were also dirty in the streets.” He noted that in terms of the U.S. greenhouse gas footprint, transportation in general accounts for about 30%, while cars and trucks make up a fifth. “If you make a lot of progress on that fifth, you will get close to some of the targets that you need to get to if we’re going to avoid a climate catastrophe.”

“The auto industry is a slow clock-speed industry and has a super long product life cycle. A fundamental business interest for them is stability in rules.” –John Paul MacDuffie

Wheels within Wheels

MacDuffie offered a glimpse into the sub-plots and postures in the debate over emissions standards. For one, the auto companies presumably had some back-channel communication with the EPA as the new rules were being framed. Their letter to Trump and the California governor “is a public stance – it has some symbolic value in terms of where the public wants to see the auto companies on this,” he said.

The Trump administration’s stance in the matter is “partly an attack on California, which in many areas has a leadership role in regulations that the Trump administration would like to eliminate,” MacDuffie continued. “The battle was set up, and to head-on attack California’s prerogatives in this was maybe part of the big goal in the first place.”

According to Orts, Trump’s position on this matter reflects his political motive “to roll back almost any Obama-era regulation.” The Trump administration also does not accept climate change as scientific reality, and that denial is “part of the populist appeal” it wants to project, he added.

MacDuffie expected the case to head to the courts. Even if the Supreme Court hears the case, it would have to consider the fact that the EPA allowing California the right to set its own emissions standards has survived every single legal challenge.

As the emissions debate is underway, Orts had a “semi-radical idea” for the auto companies. “Why don’t the auto companies just take the high road” to say that they believe climate change is an issue and embrace the higher emissions standards? “Now, it will cost them money to comply with the California standard. But that would put them in a better strategic position to be surviving long-term.”