Why Increasing CAFÉ Standards for Automobile Efficiency is a Mistake

The Obama Administration announced new regulations requiring automakers to sell cars and light trucks which average 54.5 miles per gallon by 2025.  This requires cars and light trucks to be twice as fuel-efficient as the current regulations in just 12 years.  President Obama has said:  “These fuel standards represent the single most important step we’ve ever taken to reduce our dependence on foreign oil.”  (The Keystone Pipeline might have reduced dependency even more but that was a step not taken.)   In contrast, a spokesperson for Mitt Romney said “Governor Romney opposes the extreme standards that President Obama has imposed, which will limit the choices available to American families.”

The more stringent standards are promoted as a way to reduce the demand for oil.  One way to do this is by reducing the demand for cars and driving but Bob King, President of the United Autoworkers, believes the new standards will make it cheaper to drive.  He said: “These new standards will help propel the auto industry forward by giving American families long-term relief from volatile fuel prices.  Lowering the total cost of driving will make automobiles more affordable and expand the market for new vehicles.”  Unfortunately it is quite likely that King is wrong and the more stringent regulations will increase the cost of vehicles and the cost of travel per passenger mile.

Motor vehicles contribute to traffic and air pollution (negative externalities) and use public roads.  Sensible policy includes gasoline taxes and vehicle registration fees.  It may be appropriate to raise gasoline taxes and vehicle fees if the perceived costs of the negative externalities caused by cars and trucks have increased.  It makes little sense, however, to double the fuel efficiency regulations for cars and light trucks by 2025.  The new regulations will have unintended consequences, including:

• A shift to the production of smaller vehicles that will make it more difficult for car pooling and result in even more vehicles with only a single passenger on our roads and highways.  Higher gas taxes would encourage more car pooling and reduce traffic.
• A delay in purchases of newer and more fuel-efficient (but more expensive) vehicles further increasing the average age of vehicles on the road.  Higher gas taxes would encourage people to trade in less efficient cars.
• Drivers will be encouraged to drive more often once they have incurred the fixed cost of  buying a new more efficient car.  Cars that achieve 54.5 miles per gallon will cause drivers to make more trips and increase traffic and congestion.  Higher gas prices cause drivers to economize on the number of trips and reduce traffic.
• A shift to the production of lighter and less safe vehicles.  Higher gas taxes make it more expensive to operate larger and heavier vehicles but families who value those features would still be able to purchase larger vehicles.

This is not to say that gas taxes should be raised but rather that higher gas taxes make far more sense than the new regulations which will cause families to delay trading in their older less efficient cars for newer more efficient ones.  The new regulations may make it impossible for soccer moms and dads to take their families and friends together in the same vehicle, will reduce car pooling and won’t reduce traffic and congestion.  Other than that it is a great idea.

Political Pork and (Davis) Bacon

President Obama, while campaigning in Iowa, announced $170 million in Federal meat purchases, including $100 million of pork, to help offset the expected decline in prices caused by this summer’s drought.  Ranchers have been slaughtering more animals rather than paying higher prices for feed this summer.  The shift in supply is driving meat prices down.  The President explained that the government plans to purchase more meat now at lower prices and freeze the meat  for later use, adding  “we’ve got a lot of freezers.”

The government should take advantage of lower prices for the commodities it buys because it reduces the cost of government.  It would be nice if these policies could be extended to construction labor hired for government projects.  Unfortunately the Davis Bacon Act keeps the cost of construction labor artificially high even as millions of construction workers remain unemployed or under-employed due to the collapse of the residential housing market.  For example, Federal law mandates a wage of at least $75 per hour for electricians and $71 per hour for plumbers in the city of Philadelphia for government construction projects.  Surely there are underemployed construction workers in Philadelphia who are willing and able to work on infrastructure projects for only $50 per hour.

The argument that the Federal government should intervene in commodity markets in order to dampen price fluctuations is dubious.  First, low prices are generally bad news for producers but good news for consumers.  Any government attempt to manipulate prices won’t benefit both buyers and sellers simultaneously.  (Price controls can however harm both producers and consumers).

Second, commodity producers can easily hedge against price declines by participating in futures markets (and taking a short position).  Purchasers can hedge against price increases by taking the opposite (long) position in the futures market.  For example, Southwest Airlines benefited from hedging against airplane fuel price increases when fuel prices were increasing, but lost out on their “insurance” when fuel prices fell.  The Federal government should not attempt to manipulate commodity price fluctuations when market participants could have hedged their positions in organized (and regulated) futures markets.  Nor should there be government intervention to limit the financial impact on companies from fluctuations in interest rates and the value of foreign currencies.  Companies can hedge against this volatility if such “insurance” is worth the expected cost.

Finally, if the goal is simply to lower the price of livestock feed there are better policy changes to consider.  First, as noted by the Washington Examiner, Federal energy policy now diverts billions of bushels of corn (representing 40 percent of domestic production) to the production of ethanol.  Second, our policy to tax imported sugar diverts hundreds of millions of bushels of corn per year to the production of high fructose corn syrup, a sugar substitute.  The Federal government should pursue smarter energy policies and eliminate sugar tariffs that protect sugar beet producers from foreign competition.  These policy changes would lower the artificially high price of corn and provide welcome relief to ranchers facing even higher feed prices due to the drought.

More Hours of Work are Required to Buy a Gallon of Gasoline

Gasoline prices this Memorial Day weekend are about $3.67 per gallon, about 12 cents less than last year and down about 27 cents from their peak in April.  Gasoline prices were higher, on average, in 2011 than any other year and 2012 looks to be about the same.  The nominal price of gas peaked in 2008 but fell rapidly as the recession hit the U.S. economy and ended the year at under $1.70 per gallon.  Although there are some news reports that households will drive more and travel further for vacations in the summer of 2012, any increase in travel will occur despite historically high gasoline prices.

One way to measure the relative change in the price of gasoline over time is to compare the price of a gallon of gas to the wage rate of a typical worker with a given set of skills.  The following chart calculates the number of gallons of gasoline that the median high school graduate could afford to purchase with their gross (pre-tax) earnings when working full-time.  In 1998 the median high school graduate could afford over 463 gallons of gasoline with their gross weekly full-time earnings.  By 2011 the median high school graduate could afford less than 182 gallons of gasoline with their gross full-time paycheck.

The typical blue collar worker had to work 2.5 times as many hours to fill their car’s gas tank in 2011 compared to 1998.  The situation looks no better for working class families in 2012.  The price of gasoline increased by 9.5% from the first quarter of 2011 to the first quarter of 2012.  This rate of increase was more than three times as large as the increase in the median weekly earnings of high school graduates.

The outcome of the Presidential election will depend on consumer confidence and the perceived state of the economy in swing states in November.  Working class families are likely to be encouraged by the decline in the unemployment rate and private sector job creation over the past 18 months.  But optimism about the recovery will be muted by the fact that weekly earnings for blue collar workers have increased very modestly while the price of gasoline has more than doubled since the depths of the recession in early 2009.