Monday, July 21, 2008

Why the US should raise CAFE fuel efficiency standards

[Note: Please see the previous post on Value Maps to understand the theory underpinning this post.]

CAFE: Corporate Average Fleet Economy; the average miles per gallon of a fleet of domestic autos must meet or exceed for sale in the US. For each 0.1 mpg under this CAFE fuel standard that defines an auto maker's fleet, they will be assessed a fine of $5.50 x the number of cars sold.
Autos have a complex value calculation, with innumerable attributes to analyze, such as the presence of ABS brakes, airbags, or the blinginess of the rims. To simplify our analysis, and to make a point, we can analyze just three significant components of overall product value: vehicle weight, horsepower, and fuel efficiency over time.

First, we can generally agree that the value delivered when buying a car has increased over time over the last 30 years.

A 2008 Toyota Camry delivers more value than a 1985 Toyota Camry.

In the case of weight, horsepower, and fuel efficiency, we would expect all three to increase over time, and indeed we do when we look at the data, albeit not in concert. It actually turns out that there are two phases that these attributes go through.

There are two distinct phases, but what do they mean?

Observations:

Phase 1:
- Fuel efficiency up
- Power down
- Weight down
Phase 2:
- Fuel efficiency flat
- Power up
- Weight up

Let's compare this same time frame to the CAFE fuel standards mandated for passenger vehicles.

There is a correlation between CAFE fuel standards and fuel efficiency.

Correllation does not necessarily equal causation of course, but let's take a closer look again. Let's bring back the chart with the indexed value characteristics.


Observations:

1) There is an inverse link between fuel efficiency and horsepower & weight.
2) This link makes intuitive and logical sense.
3) For the period 1975-1987, fuel efficiency grew over horsepower & weight.
4) For the period 1987-2006, horsepower & weight grew over fuel efficiency.
5) One driver of this shift is government regulation through the CAFE fuel standards.
6) The other driver is consumer and automaker choices to optimize overall value.

Analysis:

1) CAFE fuel standards has likely disrupted normal market clearing choices, pushing fuel economy higher at the expense of horsepower/weight.
2) This disruption has reduced overall consumer value.
3) We can put a dollar value on lost consumer value by converting into dollars the lower happiness of people due to a more fuel efficient car that weighs less and has less horsepower.
4) This dollar value lost is offset somewhat by lower gasoline consumption per mile.

Summary Conclusion and Recommendation:

When CAFE fuel standards go up, consumer happiness goes down (due to smaller and less powerful cars) and the US current account deficit goes down (due to fewer dollars spent on foreign oil).

As a market of individuals, we have chosen our happiness about a bigger car over the geo-political, economic, and social impacts of purchasing 10.1M barrels of oil a day from foreign producers. These externalities aren't accounted for properly by consumers in their decision process, and therefore government should intervene to disrupt the market in a way that properly accounts for these externalities. This policy decreases overall oil demand, and decreases overall consumer happiness, which is a textbook example of when government regulation in a free market is appropriate.

Source: Light Duty Automotive Technology and Fuel Economy Trends: 1975 through 2006, Ken Homa, Consultant Ninja analysis

2 comments:

Anonymous said...

The prime problem with this blog is that it is written by a consultant.

Consultants, by definition, believe their own bullshit.

As a market of individuals, we have chosen our happiness about a bigger car over the geo-political, economic, and social impacts of purchasing 10.1M barrels of oil a day from foreign producers. These externalities aren't accounted for properly by consumers in their decision process, and therefore government should intervene to disrupt the market in a way that properly accounts for these externalities.

Clearly, externalities should be internalized. However, which ones? Any how? How do we measure these externalities? How do we identify them? Well, these are then political questions - inevitably mangled and abused by politicians to serve their own 'happiness'/interests. You think Al Gore - High Priest of the Neo-Socialist Environmental Religion has your interests at heart? LOL.

I'll take the interests of a market of individuals over the interests of a few politicians any day of the week -- and twice on Sundays.

This policy decreases overall oil demand,

Such a bold and ostensibly logical statement -- yet ultimately incorrect. You should have consulted Jevon's Paradox for a bit of insight:

Standard economic theory suggests that technological improvements that increase energy efficiency will tend to increase, rather than reduce energy use.

This was first observed by William Stanley Jevons in 1865 and is called the Jevons Paradox. In The Coal Question, Jevons argued that, "It is a confusion of ideas to suppose that economical use of fuel is equivalent to diminished consumption. The very contrary is the truth."

The Jevons paradox was later revisited by the economists Daniel Khazzoom and Leonard Brookes in a series of papers about energy conservation. In 1992, the US economist Harry Saunders dubbed this hypothesis the Khazzoom-Brookes Postulate, and showed that it was true under a wide range of assumptions.[11] Increased energy efficiency tends to increase energy consumption by two means. Firstly, increased energy efficiency makes the use of energy relatively cheaper, thus encouraging increased use. Secondly, increased energy efficiency leads to increased economic growth, which pulls up energy use in the whole economy.


You want us to use less energy and shrink demand? You need to make energy MORE expensive -- not less. I thought consultants were 'smart'.

Interesting how your politics obviates Economics 101.

and decreases overall consumer happiness, which is a textbook example of when government regulation in a free market is appropriate.

Textbook example if you are a socialist.

You also miss other low hanging-fruit on the tree of knowledge. CAFE fuel standards not only encroach upon economic freedoms of both the supplier and the consumer ---- they also, very literally, kill people as numerous studies have demonstrated:

But such increases have unintended safety consequences for the safety of drivers and passengers. The reason is because carmakers build lighter and smaller cars that burn less fuel to comply with CAFE standards.11 The trade-off is these lighter, smaller cars fare much worse in violent crashes, resulting in greater rates of death and injury foroccupants.

Hhhhhhhhhmmmm. Maybe consumers aren't so stupid? Maybe they prefer larger, safer vehicles to econo-boxes? Maybe they might know a bit better about externalities and trade-offs than you and the government do?

I am such a ridiculous sado-masochist by reading this blog.

-Varangy

varangy.blogspot.com

Consultant Ninja said...

Varangy-

A few basic facts.

1) US long-term price elasticity of demand for gasoline is inelastic, estimated at 0.7*. As fuel efficiency increases, mileage does increase, but net gasoline consumption remains down.

2) A gasoline tax is more economically efficient (a few billion per year, primarily a valuation of consumer happiness and not hard dollars out of people's pockets. I would submit that it's politically impossible to pass a gas tax increase (Exhibit A: Clinton releases oil from strategic oil reserve in 2000 in the face of oil prices; Exhibit B: Bush pillories Kerry in 2004 over supporting a gas tax; Exhibit C: Gas tax holiday supported by McCain and Hillary Clinton).

3) Almost every market in the US is regulated, with a significant % of US GDP having high levels of regulation (financial services, transport, health care, consumer product goods); in all these cases the intent is to produce superior net value surplus to society than would be achieved were the free market to work without regulation. (Exhibit A: LTCM; Exhibit B: The Jungle; Exhibit C: The federal reserve tier 1, 2, and 3 ratios for banks)

4) The whole safety issue was resolved by High and Mighty, which demonstrated that SUVs actually are the cause of more deaths and injuries per car than non-SUVs, due to a) their propensity to cause severe damage to non-SUV drivers, and b) their high center of gravity and heavier weight is the source of a high number of rollover accidents.

5) It sounds like you got through economics 101 but not much further than that.

* http://www.mackinac.org/archives/1997/s1997-04.pdf

Monday, July 21, 2008