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How NOT to Respond
to Higher Gasoline Prices

By David N. Laband and 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 1970s-era 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 called for increasing “our fuel economy standards to 36 miles per gallon by 2015.”  An Episcopal Church Public Policy Network “White Paper” argued 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, 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 1975-84, a period of time when we experienced much higher gasoline prices, in real terms, than we are experiencing now.  In 1980, for example, the price of gasoline hit $1.50 per gallon in Blacksburg, Virginia.  Adjusted for transportation-related inflation from February 1980 to February 2004, the current price per gallon of that gasoline would be approximately $2.98.    People responded to that dramatic increase in the price of gasoline 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 fuel-efficient 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 $1.00 per gallon in many parts of the country. 

There was much more than CAFE regulations impacting this market to cause such a welcome fall in prices.  In fact, the regulations themselves can have the unintended effect of increasing gasoline demand if they cause drivers to spend more time on the road in fuel-efficient cars than they would in less fuel-efficient cars.  If this effect results in no net change in gasoline consumption, then CAFE regulations are inherently self-defeating to their stated purpose. 

Despite this possibility, the price of gasoline tumbled because of market forces, not because of CAFE standards (which, after all, have been set at 27.5 miles per gallon for the new passenger car fleet since 1990).  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 command controls ordered by a few bureaucrats holed up in Washington, D.C., offices.   

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 would only intensify the recent increase in the real cost of driving for motorists.  Technologically, there are two principal ways that automobile manufacturers can meet higher standards.  They can improve engine processing of the fuel, and reduce the weight of the vehicle (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 financial incentive to implement some combination of these solutions.  Historically, they did so by lightening the vehicles they produced, replacing steel with aluminum. This, of course, dramatically increased the human safety risk and financial costs of being involved in an accident because steel construction offers more protection.  (A 2001 study done by the Transportation Research Board, an “independent adviser to the federal government,” concluded that lighter and smaller cars were likely responsible for 1,300-2,600 additional highway deaths in 1993.) 

In response to this unintended consequence of government intervention in the market, air bags were required in the new car 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 $1,000 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.  Insurance premium inflation, anyone? 

There are two points to be made here which should be remembered the next time we read about traffic deaths on our highways.  First, raising CAFE standard causes the new vehicle car fleet to become lighter-weight and less-safe.  This distorts the automobile market by (i) causing some individuals to hold on to older and heavier cars longer than they otherwise would, and (ii) exacerbating the demand for sports utility vehicles that escape such regulations.  In the absence of the more stringent standard, 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 not a defensible reason to deny these individuals the opportunity to make the relevant implicit trade-offs 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 both like to see lower gasoline prices in the future.  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.

David N. Laband is a professor of economics and policy in the School of Forestry at Auburn University in Auburn, Ala.  Christopher Westley is an assistant professor of economics at Jacksonville State University in Jacksonville, Ala.

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