The impact of the corporate average fuel economy standards on technological changes in automobile fuel efficiency

Highlights

• CAFE standards increase the rate of technological improvements in passenger cars.

• The CAFE-induced effect is driven by the response of U.S. automakers.

• CAFE standards have little effect on the technical change in light-duty trucks.

• Higher gasoline prices accelerate the improvement of fuel-saving technology.

Abstract

This paper empirically examines the effect of the U.S. Corporate Average Fuel Economy (CAFE) standards on the technological progress in automobile fuel efficiency. Using detailed vehicle attributes data from 1978 through 2018, we find that more stringent fuel economy standards increase the rate of technological improvements in new passenger cars, and this effect is primarily driven by the response of U.S. automakers. We do not find evidence that CAFE standards have a similar effect on the technical change in light-duty trucks. Our results also indicate that higher gasoline prices have a significant and positive effect on the improvement of fuel-saving technology in both passenger cars and light trucks. Using our empirical estimates, we project that the recent rollback of Obama-era CAFE standards would forego an approximately 2-percent increase in cars’ fuel economy over the 2021–2025 period as a result of technological progress.

Introduction

Researchers have long sought to understand how public policy influences technological changes. This question is particularly crucial in the area of environmental and energy policy, where the development of clean energy technologies corrects the negative externality of fossil fuel consumption and helps to address long-term environmental problems such as climate change. Given the mounting concerns about climate change, how to facilitate technological progress that reduces fossil fuel consumption and greenhouse gas (GHG) emissions has been a critical question for both researchers and policymakers. In this paper, we investigate the drivers of technological progress in vehicle fuel efficiency in the United States, with a particular focus on the federal Corporate Average Fuel Economy (CAFE) standards. The transportation sector has become one of the largest sources of GHG emissions in the nation, and within the sector, light-duty vehicles are responsible for about 60 percent of GHG emissions (EPA, 2017). The federal and state governments have implemented a set of policies to cut transport-related fuel consumption and carbon emissions. CAFE standards have been one of the most prominent and controversial policy instruments.

The CAFE standards were first enacted by Congress in 1975, with the goal of promoting fuel conservation and energy independence after the 1973 oil crisis. The standards require auto manufacturers to meet a minimum sales-weighted average level of fuel economy (measured in miles per gallon, or mpg) for their new fleets of light vehicles sold in the U.S in each model year (MY). In the first ten years after being introduced, CAFE standards rose sharply for both passenger cars and light-duty trucks (including pickups, minivans and sport utility vehicles, or SUVs), and then remained stagnant for nearly twenty years till they were renewed by the Bush administration. CAFE standards were further tightened by the Obama administration, which required a combined fleet-wide fuel economy of 41 mpg by 2021 and promulgated a schedule of gradually stricter standards through 2025. The Trump administration has recently announced a new rule to roll back the Obama-era fuel economy standards by lowering the stringency level from 2021 through 2026.

A growing body of research has examined the behavioral and welfare implications of CAFE standards. Prior research has generally suggested a positive effect of CAFE on increasing average mpg (Greene, 1990; 1999; Goldberg, 1998; Kleit, 2004). But less is known about CAFE’s direct impact on the technological change in vehicle fuel efficiency. Importantly, automakers can employ different strategies to comply with more stringent fuel economy standards. While one option is to develop better fuel-saving technologies, they could also choose to sacrifice other vehicle attributes such as engine power. Because CAFE standards focus on the sales-weighted average mpg, automakers might also adjust their vehicle prices (e.g., by raising prices of low mpg vehicles) and fleet mix to meet the standards in the short term (Goldberg, 1998). In this study, we examine the technological change based on applications of new inventions, designs, more advanced materials, or techniques that lead to improved vehicle fuel economy. Understanding whether and how CAFE affects the advancement of fuel-saving technologies is useful for assessing automakers’ response to and capability to meet more stringent standards as well as their compliance costs.

Our empirical analysis uses detailed vehicle attributes data for nearly all light vehicle models sold in the United States in 1978–2018 to estimate CAFE-induced technological change. Using a product attributes framework, we first examine the technological trade-off between fuel economy, horsepower, and curb weight, and estimate the annual increase in average fleet fuel economy when holding other vehicle attributes constant. Then we model technical change as a linear function of annual changes in CAFE standards and recent gasoline prices. Overall, we find that CAFE standards have a significant, positive effect on fuel-saving technology improvements in new passenger cars, while its effect is not statistically significant in light-duty trucks. The CAFE-induced technological responses are mainly driven by U.S. car manufacturers. We also find that higher gasoline prices accelerate the rate of technological improvements in fuel efficiency in both passenger cars and light trucks, and U.S. automakers have shown stronger responses to fuel prices than their European and Asian peers. Using our empirical estimates, we project that the recent rollback of Obama-era CAFE standards would forego an approximately 2-percent increase in vehicle fuel economy over the 2021–2025 period as a result of technological progress.

Our research builds upon past research on the economics of innovation in the energy sector (for a review of this topic, see Popp et al., 2010), and contributes to the CAFE literature and policy discussion in several ways. First, we examine the technological responses to CAFE standards using a much longer panel dataset (MYs 1978–2018) compared to previous studies (Knittel, 2012; Klier and Linn, 2016). This longer time series allows us to exploit the policy’s variation during its initial phase-in period and later reforms since the mid 2000s in estimating its impact on technological change. Second, our analysis distinguishes automakers by their country origins and examines their heterogeneous responses to the U.S. fuel economy standards and fuel prices. We also quantify the rates of technological progress at the market and firm levels, which provide similar evidence on automakers’ response to changing fuel economy standards. Third, our empirical estimates are useful for assessing the feasibility of attaining fuel economy standards at different stringency levels and estimating manufacturers’ compliance strategies and costs. Nonetheless, we note that this paper does not directly investigate the aggregate welfare effects of CAFE standards. But our estimation of is direct impact on technological changes could inform a more comprehensive evaluation of CAFE’s long-term benefits.

The remainder of the paper proceeds as follows. The next section discusses the policy background of CAFE standards and relevant literature. The subsequent sections describe our data sources, empirical models, and estimation results. The last section concludes with a discussion of our research findings and limitations.