Just tightening failed CAFE standards will not work out Xiaojiao Chen February 3 rd, 2010

Criterions of judging governmental interventions: Whether the intervention could achieve its objectives; Whether the intervention is cost-effective. Are there other less costly alternatives to achieve the same objectives?

CAFE doesnt achieve its initial objectives in the cost-effective way. Objectives of CAFE: To reduce oil intensity and therefore decrease oil consumptions; In this way CAFE is supposed to: mitigate externalities of both oil dependency and environmental impacts; correct the imperfect.

CAFE doesnt achieve its initial objectives in the cost-effective way. Check out the cruel facts: 1.CAFE didnt not increase average fuel economy in U.S.; 2. The effect of addressing global warming problems is ambiguous and CAFE even increases local pollutions slightly; 3.Costs of correcting the imperfect market of fuel economy may exceed the benefits.

CAFE didnt not increase average fuel economy in U.S.;

CAFE doesnt address environmental externalities well Global warming Local pollutions

Costs of correcting the imperfect market Costs of implementing a new technology Forgone performance enhancements Forgone R&D opportunity costs

Other unintended consequences of CAFE The rebound effects Opportunity costs of consumers Fleet mix effects

The rebound effects Congestion costs=the value of travel time * the extra time of driving Parry and Small 2001: 3.5 cents per mile Accident costs: Parry and Small 2001: 3 cents per mile The rebound effects=(congestion costs + accident costs) * 15% * 20miles/gallon= 19.5 cents per gallon Compare: externalities cents per gallon

Opportunity costs of consumers The happiness of consumers If consumers correctly perceive fuel savings but value technologies more: Technology transfer from other techs(high value) to fuel economy techs=welfare loss See Mckinsey Abatement Cost Curve:

Mckinsey Abatement Cost Curve

Fleet Mix effect If CAFE leads to lighter vehicles, how would this affect safety? Weight reduction of cars increase fatality risk while weight reduction of light trucks decrease fatality risks;

Suggestions Modifications of CAFE Alternatives

Modifications of CAFE: tradable fuel economy credits Problem: same standard regardless of costs High marginal costs VS low marginal costs Caution: appropriate cap

Alternatives Tax breaks or rebate Financial source; Hard to stop; No influence on the actual driving amount; Insurance No incentives to spur fuel economy; hard to track Broad oil tax Political feasibility? Fairness?