MARKETS, REGULATION AND INNOVATION IN ROAD TRANSPORT

REGULATION OF VEHICLE EFFICIENCY IN THE US

This is intended to be the first of a number of short comments on road transport and its potential contribution to environmental objectives. These  will look at the different instruments by which we seek to control carbon emissions and the respective roles of markets, regulation, and innovation. These are not mutually exclusive but usually complementary.  As we contemplate just how we will meet the ambitious targets of Paris (COP 21), experience to date in the road transport sector has some important lessons. This comment focuses on a measure of how effective relatively simple regulatory measures can be. The chosen example is a historical one - US regulation to reduce road fuel consumption after the oil crises of the 1970s, and the impact of an anti-environmental backlash in the mid 1980s. It demonstrates both the impact of policy measures, and of course also the cost of policy mistakes.

Managing problems in road transport

One standard market economics response to dealing with "externalities", of industries or products that have serious side effects or adverse consequences for society as a whole, is to try to capture at least some of the externality by imposing taxes that penalise the polluters, thereby internalising this cost for the industry, and providing incentives both for innovation and reduced use. There is no doubt that prices generally can work in the way we expect they would, reducing demand for the commodity that is being more highly priced or taxed.

One illustration of the long term influence of prices is the claim that the US became accustomed to enjoyment of much larger and less efficient passenger vehicles because its gasolene prices were so low, although the primary reason for this was not environmental per se but because the US had never used road fuel taxes as a revenue raiser in the way that European countries have. More generally there are plenty of examples of economies, like Germany, which are competitive and productive in spite of high energy prices.  High energy prices force high levels of energy efficiency.

But prices and energy efficiency are not the whole story, and transport has plenty of other interesting lessons for us. The other problem areas of road transport are in health and safety, with road accident casualties and air pollution, and in the economic and personal costs of traffic congestion. These are also economic externalities, but our approach to them is often through regulation. We do not rely on taxation to control vehicle speeds, nor in general do we try to create markets in speed. Instead we have speed limits. Similarly we tend to rely on regulation not markets to protect air quality.

Congestion is a different story. The first London  mayor, paradoxically (for some) an avowed socialist, introduced a form of “market” solution in the form of  a congestion charge. A later comment will address some of the successes and shortcomings of those particular schemes, but in essence he was implementing a form of road pricing that transport economists had been recommending for decades.

CAFE Regulations in the US. Showing the effect of regulation

The US responded to the oil crises of the 1970s by subjecting the vehicle industry to quite stringent regulations, the Corporate Average Fuel Economy (CAFE) standards, to improve energy efficiency and the fuel economy of vehicles . It is an interesting observation in itself that the US did not choose to rely on the "market" approach of gasoline taxes as its primary instrument to deal with the perceived threats to US energy security. Instead it relied  on subjecting the vehicle industry to quite stringent regulations to improve energy efficiency.

I have chosen this example because its effects were well documented by Lutsey and Sperling,  with the particularly easy to follow graphical representation shown above.

As the authors say, there was a strongly positive and relatively constant rate of improvement from 1975. This is clear for both their measure of technical energy efficiency, ton-miles per gallon, and for vehicle fuel economy, miles per gallon. In fact until the mid 1980s the rates of improvement in both moved in close correlation.

But during the mid 1980s, an anti-environmental backlash resulted in a major change. Innovation allowed continued technical improvement, but the trend in vehicle fuel economy stalled. Robert Kennedy was able to claim in 2001 that “The CAFE standards worked so well that they produced an oil glut by 1986. That's when the Reagan administration intervened to rescue America's domestic oil industry from gasoline price collapse. Ronald Reagan's rollback of CAFE standards caused America, in that year, to double oil imports from the Persian Gulf nations …."  [NY Times.24 November 2001]

After 1986 technical efficiency continued to improve but the gains were realised, not in vehicle economy but in heavier vehicles, and, among other factors, more power and better acceleration. Prices have at most a limited role to play in this story. This was not a market failure but a policy choice. To quote Lutsey and Sperling, the benefits of technological innovation were used to satisfy private desires (power, size and amenity) rather than the public interest ( fuel security and lower greenhouse gas emissions). 

Ironically the US retained a national maximum speed limit of 55 mph, a rather low number by international  standards, until 1995. Both speed and congestion are major influences on fuel consumption.