Lemons From Lemonade

There’s a reason they call it the “dismal science.” Just when we think we’ve done something we can feel good about, the economists show up to rob us of some of our hard-won self-satisfaction.

In case you missed it, the Obama administration just decided to dramatically increase fuel economy standards nationwide. The new regulations mandate that by 2016 the fuel economy of new cars and light trucks sold in the U.S. increase to a combined city/highway m.p.g. of 35.5, up from about 27.9 under today’s CAFE standards.

Although hybrids and electric vehicles can help automakers meet these targets, enough efficiency can be reaped with internal combustion autos. This can come through improvements to things like tires, engines (e.g. smaller ones with turbocharging), air conditioning, transmissions, and vehicle weight. The administration estimates that this will cost $1,100 per vehicle but that the improvements will pay for themselves with $3,000 in fuel savings over the life of the car.

Cleaner air, a cooler planet, fatter wallets, and slimmer trade deficits; O.K., economists, what’s not to like?

The problem is that lurking beneath the regulations’ noble intent lie some perverse incentives which may cause unintended consequences. These tend to pop up in transportation: improved auto safety technology may induce us to drive more dangerously, and by reducing congestion, investments in mass transit may cause some people to drive who ordinarily wouldn’t have.

Previously, I blogged about the rebound effect, which dictates that some of the gains from improved fuel efficiency will be eroded as drivers respond to lower gas costs by driving more. Kenneth A. Small and Kurt Van Dender of the University of California at Irvine estimate that about 10 percent of the fuel savings from better mileage will be dissipated thanks to increased vehicle miles traveled.

And there’s more, according to a new paper (gated) by Lawrence H. Goulder, Mark R. Jacobsen, and Arthur A. van Benthem.

According to the authors, the increase in new car prices that will result from incorporating fuel-saving technology will make used cars more valuable. To avoid shelling out for new models, drivers will have an incentive to keep aging, fuel-hungry vehicles on the roads and off the scrap heap. The authors estimate that 24 to 39 percent of the fuel savings from adoption of the new standard will be lost as a result of prolonging the life of the used car fleet.

The authors are also less sanguine than the administration about the monetary savings from this initiative. In part due to the used car effect, they calculate the new standards will cost about $4.50 to $6.00 per gallon of fuel saved. Given the external costs of fuel consumption, such as pollution, I feel this tradeoff is worthwhile. But backers’ claims that the new standards will pay for themselves may be misplaced, at least without a big runup in gas prices.

Perhaps the picture is not as grim as the authors paint. They did not take the effects of Cash for Clunkers into consideration; 700,000 of our most gas-guzzling used cars have just been taken off the road entirely.

Also, depending on the models involved and their mileage, keeping used cars around a bit longer may ultimately have benefits for the environment, given the energy that goes in to building a new car (see this or this). Finally, there is a chance that technological improvements will eventually reduce the cost of the new fuel efficiency measures.

Still, some of the effect the authors predict will be felt; the lifetimes of some inefficient cars will be extended thanks to the new standards. Leave it to the economists to turn our lemonade into lemons — as in more lemons on our roadways.