Raising CAFE Reasonably
By Jeremy Anwyl July 20, 2011
Negotiations on raising the debt limit have grabbed most of the attention in the nation’s Capitol, but another Washington negotiation is in its final phases as well. The Administration, automakers and environmentalists are discussing the proposed Corporate Average Fuel Economy (CAFE) standards; loosely stated, CAFE is a set of average mileage "quotas" per fleet that automakers must meet. Missing from the negotiations are consumers, the folks who would presumably be buying a new generation of high-mileage vehicles.
Should consumers be concerned? Better gas mileage sounds good. Are there any downsides? First, we need to understand that while the proposed number -- 56.2 miles per gallon -- sounds like a big jump from where we are today. It is, in fact, not as big as it seems. CAFE mpg, a very complex calculation, is not the same as the Environmental Protection Agency (EPA) measured mpg we see on new vehicles’ window stickers. There's an explanation here for the reason the numbers don’t match. A CAFE standard of 56.2 mpg actually roughly translates to an EPA rating of 41 mpg.
A second example of CAFE’s complexity is that different types of vehicles have to hit different standards. This means that pickup trucks have a lower target than passenger cars. This might sound OK, but it is exactly this kind of “tweak” that can cause unexpected outcomes. Case in point: Ever wonder why SUVs became so popular? Back in the Sixties, SUVs were mainly bought by the limited audience of consumers who wanted them for towing and off-road driving. When CAFE was introduced in the Seventies, trucks and SUVs – thought of as work trucks for contractors and farmers –were given a pass. Consumers, looking for alternatives to a new generation of CAFE-mandated downsized cars, started to buy them, especially when fuel prices fell. Car companies noticed and began making SUVs more car-like. Sales exploded. It was the truck loophole in the original CAFE standards that triggered the rise of the gas-guzzling full-size SUV. Ironic, isn’t it?
Before I get to the proposed CAFE plan, there is something more basic to consider: CAFE is actually a very poor way to improve the fuel efficiency of vehicles. Rooted in its design is the risk that automakers will be forced to build vehicles that the market does not want. This is fundamentally a bad idea. If government and society want to reduce emissions and the use of non-renewable fuels, the hands-down best way to do this is to increase the cost of these fuels. We have seen over and over again that higher fuel prices shift consumer demand to more fuel-efficient vehicles. In a notionally market-driven economy, managing demand is the key, not production. I have pointed this out before, so I understand that people don’t want to hear about a gas tax. Like any tax, there are drawbacks, but it still is the best approach.
Also rooted in the design of CAFE is the assumption that car companies can build more fuel-efficient vehicles that consumers want to buy, but simply choose not to. This is not the case. Even without increasing CAFE standards, car companies have increased their fuel-economy performance. Although CAFE standards for passenger cars stayed the same from 1990 to 2010 at 27.5mpg, actual CAFE performance went from 28.0 mpg to 33.7 mpg in that same period. Since the gas price spike of 2008, we have seen an even higher rate of performance. Along with this improved performance, vehicles have gotten heavier – quite a bit heavier, in fact. The average vehicle weight was 3,156 pounds in 1990 and had jumped to 4,165 pounds in 2010. Several factors are involved. Meeting new safety requirements adds weight. So does increasing features and extra equipment on a vehicle. All things being equal, extra weight lowers fuel efficiency. But as noted, both weight and fuel economy have increased. How can this be?
The answer is technology. The internal combustion engine is actually not that efficient. The pace of advancing technology that has touched all corners of our lives has been applied to engines as well. Technological advances have allowed automakers to -- for a given engine size -- increase horsepower, fuel efficiency or both. This is why today’s six-cylinder Chevrolet Camaro, for example, performs like an eight-cylinder version from just a few years back, and it delivers better fuel economy, too. This would seem like a win all the way round. Consumers get the vehicles they want, but fuel efficiency and emissions are improved as well. And it is. The rub is that there is a pace to this technology-powered increase in efficiency. And this pace is not fast enough to keep up with the CAFE standards being proposed.
This brings us to the proposed new standards. I mentioned earlier that the existing CAFE standards already are very complex. The proposed new standards actually increase this complexity. Complexity reduces transparency, adds to costs and creates loopholes. So right off the bat, there is a problem. When deciding CAFE, we basically have three options. The first is to do nothing; keep the standards as they are. If we did that, we estimate that by 2025, assuming a continued increase in the price of fuel, industry CAFE will have reached around 40 mpg, or 30 mpg as measured by the EPA.
The second is to increase the standards to push performance beyond the “do nothing” scenario, but not to the point where the vehicles that automakers must build are completely out of sync with the vehicles that consumers want to buy. There is some risk to this scenario. Car companies may have to raise the prices of less efficient vehicles simply to shift demand to more efficient vehicles. They would also be prodded to adopt advanced technologies at a faster pace than they would prefer, increasing the risk of introducing technology that is not ready for the public. Also, the use of lightweight aluminum and composites would increase. These advanced technologies and materials are expensive, and this would further raise prices.
The third scenario is to set the bar high. Assume that future fuel prices will be sharply higher and that this will permanently shift demand to smaller vehicles. Also assume that new technologies can and will be created to respond to the higher standards. Setting the bar high sounds good. It signals a commitment to improving the environment. What could be better than that? But it carries huge risks as well. We have actually seen this play out before. CAFE and emissions standards were first introduced at a time when the domestic auto industry had been focused on meeting domestic demand for large vehicles. Automakers had to rush to find new technologies that could be used to power vehicles that met the standards and also pleased consumers. They failed. This resulted in a generation of vehicles these automakers would probably like to forget and that caused the reputational damage that still lingers even today.
This leads me to conclude that we all would be best served under my second scenario. Establish new standards to push the rate of improvement higher, but don’t push so hard that things break. The standards should be simple and easy to understand, with no loopholes. Let the car companies figure out how to “ration” sales to meet the targets. My best estimate is that under this scenario the CAFE standard for all light vehicles should be set for about 45 mpg by 2025. This may not appear to stretch much past the 35.5 mpg standard set for the 2016 model year, but this number is not an apples-to- apples comparison. My proposed standard has no loopholes. It should truly keep customers satisfied, support a balance of technological development and risk, improve the environment and reduce the use of non-renewable fuels.
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