Freeman

ARTICLE

How Not to Respond to Higher Gasoline Prices

JULY 01, 2010 by DAVID LABAND, CHRISTOPHER WESTLEY

Mix together surging gasoline prices, a conflict in the Middle East, and a presidential election year, and what do you get? Given the sorry state of economic education among our political elites, you are likely to find bad energy – policy proposals and an increased willingness to intervene in the very market forces that are necessary to promote trade, peace, and wealth creation.

This likelihood is exemplified in the recent calls for raising the Corporate Average Fuel Economy (CAFE) standards. These 1970sera regulations require the average car produced by an automobile manufacturer to meet a prescribed fuel-efficiency target in terms of miles per gallon.

They have always been popular with the left. Presidential candidate John F. Kerry’s web site calls for increasing “our fuel economy standards to 36 miles per gallon by 2 0 1 5 . ” An Episcopal Church Public Policy Network “White Paper” argues that the “biggest single step we can take to save oil and curb global warming is to raise [CAFE] standards for both cars and light trucks.” Newspapers from the Seattle Times to the Birmingham News have editorialized this year in favor of raising CAFE standards.

This knee-jerk proposal becomes popular every time gas prices spike at the pump, and we couldn’t disagree more. Not only would raising CAFE requirements restrict individual choice and weaken the property rights of manufacturers, but the costs to drivers almost certainly outweigh the benefits, on average. This means that the cure would be worse than the disease.

CAFE standards were raised significantly from 1975 to 1984, a period when we experienced much higher gasoline prices, in real terms, than we are experiencing now. In 1980, for example, the price of gasoline hit $ 1 . 5 0 per gallon in Blacksburg, Virginia. Adjusted for transportation-related inflation from February 1980 to February 2 0 0 4 , the current price per gallon of that gasoline would be approximately $2.98. People responded to that dramatic price increase by changing their behavior in ways that reduced the overall cost of driving: they carpooled more; they planned their shopping more carefully to reduce the number of driving trips taken; and they bought more fuelefficient cars. Oh, and by the way, the federal government raised CAFE requirements.

The high price of gasoline not only motivated changes in driver behavior, which led to decreased demand for gasoline; it also stimulated substantial new oil exploration and development of new reserves. The combination of reduced demand and increased supply had a predictable, if not inevitable, effect on gasoline prices. Starting in the mid-1980s, gasoline prices started coming down. . . and down . . . and down. Just three years ago, we were paying well under a dollar per gallon in many parts of the country.

Much more than CAFE regulations caused such a welcome fall in prices. In fact, the regulations themselves can have the unintended effect of increasing gasoline demand if they encourage drivers to spend additional time on the road in more fuel-efficient cars than they would in less fuel-efficient cars. If this effect results in no net change in gasoline consumption, then CAFE is inherently selfdefeating in its stated purpose.

Despite this possibility, the price of gasoline tumbled in the 1990s because of market forces, not because of CAFE standards (which, after all, have been set at 2 7 .5 miles per gallon for the new passenger car fleet since 1 9 9 0 ) . This result is hardly surprising. Price signals dispersed among millions of independent economic actors play a much more significant role in affecting gasoline prices than commands from a few bureaucrats holed up in Washington, D.C.

Such economic history suggests that gas prices have both risen and fallen in spite of CAFE standards. Indeed, there are compelling reasons to believe that such standards only intensify the recent increase in the real cost of driving for motorists. Technologically, automobile manufacturers can meet higher standards in two principal ways. They can improve engine processing of the fuel and reduce the weight of vehicles (since a gallon of gasoline can push a lighter vehicle farther than a heavier vehicle). Automobile firms, which have paid over a half a billion dollars since 1983 in CAFE related civil fines, have a strong incentive to implement some combination of these solutions. Historically, they did so by lightening the vehicles, replacing steel with aluminum. Because steel construction offers more protection, lightening the vehicles dramatically increased the safety risk and financial costs of being in an accident. (A 2 0 0 1 study done by the Transportation Research Board, an “independent adviser to the federal government,” concluded that lighter and smaller cars were likely responsible for 1 , 3 0 0 – 2 , 6 00 additional highway deaths in 1 9 9 3 . 1)

Air Bags Required

In response to this unintended consequence of government intervention in the market, air bags were required in the newcar fleet, another costly result of CAFE because federal safety rules do not allow for air bags to be reused. “Add the cost of labor, more than $ 1 , 0 0 0 for each air bag, and even more for the sensors, and the result is a totaled car,” writes Eric Evarts in the Christian Science Monitor.2 Insurance-premium inflation, anyone?

Two points should be remembered the next time we read about traffic deaths on our highways. First, the lighter and less safe fleet of cars, thanks to CAFE, distorts the automobile market by causing some individuals to keep older and heavier cars longer than they otherwise would, and by increasing the demand for sports-utility vehicles, which escape such regulations. In the absence of more stringent mileage standards, at least some of these individuals would gladly pay more for gasoline (per year) in order to drive less fuel-efficient, but safer cars. There simply is no defensible reason to deny those people the opportunity to make the relevant implicit tradeoffs themselves, rather than trusting that the supposed savings in gasoline prices would, in fact, exceed the benefit from safer vehicles.

Second, CAFE standards inevitably lead to significantly higher vehicle costs and higher risk costs with little evidence that they are responsible, by themselves, for lowering gasoline prices. This implies that the social costs of raising CAFE standards substantially exceed the social benefits. As the saying goes, the road to hell is paved with good intentions. We’d like to see lower gasoline prices. Thanks to the laws of supply and demand, the existence of higher than – average prices virtually guarantees that prices will come down. Raising CAFE standards hinders this process and puts us on a road we don’t want to be driving.

1. “Effectiveness and Impact of Corporate Average Fuel Economy (CAFE) Standards.” See Finding 2 at http://books.nap.edu/books/0309076013/html/3.html#pagetop.
2. “New Cars Are Getting Too Expensive to Fix,” Christian Science Monitor, April 19, 2004.

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