The value car buyers assign to fuel economy has important implications for policies to reduce greenhouse gas emissions and fuel consumption. If consumers undervalue fuel economy over the life of a vehicle, the market will provide too little fuel economy and will under-invest in research and development of energy-efficient technologies. At the same time, policies that influence the market via regulatory policies, such as fuel economy standards or purchase price schemes, will have greater leverage on fuel economy than fuel prices.
Behavioural economists argue that when faced with a risky bet, consumers exaggerate the probability of loss and weigh potential losses maybe by twice as much as potential gains. Energy efficiency is a risky bet for consumers because of uncertainty about future fuel prices, the true in-use energy efficiencies of vehicles as opposed to their official ratings, future vehicle use and vehicle lifetime. Uncertainty and loss aversion could explain consumers’ lack of interest in quantifying potential future fuel savings. It may also explain manufacturer reluctance to invest in fuel economy.
Like any industry, auto manufacturers need a stable regulatory environment for the large capital investments needed to improve fuel economy. This is all the more important if they are expected to shift to new energy sources. Standards can help provide this certainty and the longer the planning horizon the better. Binding standards for the short term can be complemented by indicative targets for the longer term; the EU standard of 120gCO2/km by 2012 for new cars is accompanied by a tighter 95gCO2/km target for 2020, for instance. Such standards may outperform taxes when it comes to stimulating innovation because they act where the innovative effort is concentrated.
In any case, some sort of carbon-related tax rate differentiation is now included in the motor vehicle taxes in a number of OECD countries, according to a 2009 study, which also indicates that some of these “green” taxes could be better geared to reducing carbon emissions rather than just raising revenue. From an environmental point of view, the arguments for applying a higher tax rate per tonne of CO2 emitted from an expensive vehicle than from a cheaper one seem weak, the study concludes.
What about temporary subsidies? These can help overcome the cost disadvantage of small scale production. They are separate from subsidies for R&D, which are justified on the basis of knowledge spillovers. For efficiency, subsidies should be as technology neutral as possible, though this can prove tricky in practice. And even though subsidies are intended to be temporary, ending them is not easy, even after their original goals have been reached. This is a strong argument for avoiding subsidies in the first place.
On the other hand, manufacturers working on new cars do not want to see purchase subsidies for electric or fuel cell vehicles cut back before they can recoup their development costs. Governments may guarantee such subsides for a few years, but just getting new products to market may take up most of that time. Electric vehicle subsidies in France, Germany and especially the UK have been structured to provide some security in this respect.
In sum, the risks associated with subsidies are legion, and any reluctant support for them is based on the premise that breakthrough technologies are needed if the energy base of transport is to be transformed. Also, the transformative efforts required for very low carbon transport should not necessarily be expected to fall on industry’s shoulders alone, and some even quite costly policy support may be needed. If the costs of not intervening are higher than the benefits, then that may be a risk worth taking. RC
OECD (2009), “Incentives for CO2 emission reductions in current motor vehicle taxes”, Nils Axel Braathen, Environment Directorate, Unclassified, Paris.
Greene, David (2010), “Why the New Market for New Passenger Cars Generally Undervalues Fuel Economy”, Discussion Paper 2010-6, Oak Ridge National Laboratory, Transportation Research Center, US.
International Transport Forum (2010), “Stimulating low-carbon vehicle technologies”, Discussion Paper No 2010-13, May.
These papers are available at www.internationaltransportforum.org/jtrc/roundtables. html and will be published in the ITF/OECD Roundtable series later this year.
©OECD Observer No 279 May 2010