Ideas to Action:

Independent research for global prosperity


Views from the Center


This is a joint posting with David Wheeler and Robin Kraft

When countries in Latin America or Africa descend into crisis, economists in Washington take a harsh view. Governments are forced to reduce spending in return for IMF rescue packages and in some instances, countries are even put on a cash-only budget. In the United States, we have a very different approach designed to minimize hardship of any kind -- the bailout.

General Motors and its American competitors, Ford and Chrysler, are currently asking for a bailout -- the second request in 2008. The first was quietly and quickly met with a cash infusion of $25 billion. But this second request has not been so easy -- it has led to a heated discussion about jobs, the importance of having a homegrown auto sector and the automobile as an icon of American culture. But there has been relatively little said about the two major policy distortions that have created this mess -- the distortion of price signals as mandated by the Corporate Average Fuel Efficiency (CAFE) standards and the lack of portability of pension and health benefits in the U.S. economy as a whole.

In this post, we will consider the contribution of a weak CAFE standard to the current crisis. The figure below shows fuel efficiency standards in several countries as compared with the CAFE standards of the United States. It is abundantly clear that of all the countries in the figure, the United States is at the very bottom in terms of fuel efficiency standards. California has attempted to break away, but this effort has been met with enormous resistance from the federal government. While Europe and Japan have reached for 40 to 45 miles per gallon, the United States has set its goals at under 30 mpg.

CAFE-‘equivalent’ fuel standards around the world

CAFE-'equivalent' fuel standards around the world

Source: International Council on Clean Transportation, adapted from Pew Climate

There are other policy distortions as well. The explosion of SUVs in this country did not result from the preferences of Americans to drive large cars. Rather, it is the result of a loophole in the law that puts "light trucks" of less than 8500 lbs in their own category of fuel efficiency, effectively exempting pickup trucks, minivans and SUVs from more stringent fuel-economy standards. This policy decision has had enormous consequences -- light trucks were a small portion of sales in the 1970s, but they have accounted for 50% of all sales in recent years. This and other loopholes were at least in part due to intense lobbying by the auto industry that has made raising CAFE standards a decades-long process with few results.

Europe has long recognized the importance of price signals. And by getting prices right, the market has delivered smaller, more fuel-efficient cars. But as an op-ed in the Boston Globe pointed out in 2007, "the most astounding fact is that many of the European high fuel-economy vehicles are produced by U.S. car makers. How can the government let manufacturers continue to convince the nation that a fuel economy of over 35 miles per gallon is difficult to achieve?"

Even China seems to be removing policy distortions. Maximum fuel consumption standards there are based on weight class and, and excise taxes increase with engine size (3% for a 1-1.5 liter engine displacement, 20% for engines greater than 4 liters). Until recently SUVs of any size were taxed at 5%, but they now fall under the engine size-based tax regime.

Some argue that if the United States reduced its fuel subsidies -- estimated at between $3 and $10 a gallon to account for oil company tax breaks and costs associated with regulatory oversight, pollution cleanup and liability -- the price of gas in the United States would be a lot closer to the price in Europe. This would in turn lead to a very different mix of automobiles in the U.S. market.

Gasoline Prices

It is worth noting that Ford leads the industry across Europe's main 19 markets with a 9.9 per cent market share. In 2007, GM -- for the second consecutive year -- set an all-time sales record of nearly 2.2 million passenger cars and light commercial vehicles in Europe, achieving a market share of 9.5 percent. But here in the United States, policy distortions have greatly affected the production decisions of Japanese, European and American automakers and the mix of fuel-efficient vs. non fuel-efficient cars. These decisions turned disastrous when fuel prices went through the roof in 2007 and 2008. GM and its American competitors have suffered enormous declines in the sales of larger vehicles which they had become so good at producing for the U.S. market. After dismissing outright for many years the need to produce fuel-efficient cars, GM has grudgingly coming around to designing the Chevy Volt. And coming at such a late stage in the game, this move has been fraught with difficulties.

The moral of the story is that had we paid more attention to regulatory policy in decades past, we would not be debating the bailout of General Motors today. We need to stop focusing the blame on managers (from the left) or workers (from the right) for the Big Three mess. Yelling "off with their heads" might have been good enough for Lewis Carroll's Red Queen, but it ain't going to resolve anything fundamental. Both managers and workers have shot themselves in the foot by advocating for and then responding to policy distortions that have gotten price signals all wrong. If we really want to fix this, we have to fix the policies that have produced artificially low gas prices and low fuel-efficiency vehicles. Then, the managers and workers of GM and Ford will magically become as "smart" and "competent" as their counterparts in Europe and Asia. And the developing world will get the right message as well -- that good policy begins at home.


CGD blog posts reflect the views of the authors drawing on prior research and experience in their areas of expertise. CGD does not take institutional positions.