In anticipation of the Senate debate on the Corporate Average Fuel Economy (CAFE) program, The Heritage Foundation (THF) and the Competitive Enterprise Institute (CEI) recently hosted a panel of four recognized experts to discuss the public policy implications of the CAFE program and to examine its effects on consumers and the economy. Panelists included Dr. Robert W. Crandall, Senior Fellow in the economic study program at the Brookings Institution; Barry Felrice, Senior Manager of Regulatory Affairs for the Daimler Chrysler Corporation; Sam Kazman, General Counsel of CEI; and Dr. W. David Montgomery, Vice President of Charles River Associates. Edited excerpts from this discussion are presented below.

Introduction

Congress established the Corporate Average Fuel Economy program better known as the CAFE program in 1975. This program requires auto manufacturers selling in the United States to meet certain fuel efficiency standards and levels for their fleet of new cars and light trucks comprised of pickups, minivans, and sport utility vehicles (SUVs). The standard for passenger cars is currently 27.5 miles per gallon and 20.7 miles per gallon for light trucks. Some in Congress, such as Senator John Kerry, want to drastically increase standards to force manufacturers to build cars and light trucks that would get 35 miles to the gallon by 2013.

The goals of CAFE standards were to reduce US dependence on foreign oil and decrease the consumption of gasoline. Yet, today the United States imports more oil than when the CAFE program was enacted and people are driving more miles. The program has also had unintended consequences.

Excerpts from Dr. Crandall

We needed CAFE in 1975 (or the Congress thought it did) not because of the Arab oil embargo but because the way in which Congress responded to it. Having put regulatory mechanisms in place to keep the price of oil and gasoline artificially low, they needed to offset those incorrect market signals so as not to induce General Motors, Ford and Chrysler to continue to produce gas-guzzling cars. Had they let the price of oil and gasoline rise market mechanisms would have taken care of this perfectly well.

CAFE is a solution in search of a problem. Is the problem global warming? Is it energy security? Is it traffic congestion and air pollution? Or is it simply the envy of some people who can't afford to buy large SUVs? I think that I can say confidently that except for, perhaps, a subset of that last problem, CAFE is not the right solution to whatever the problem advocated is.

That's the problem with any CAFE standard: it only targets a very, very small subset of those people using energy, namely, those people who buy new motor vehicles principally for pleasure usage. It doesn't target those people who drive older motor vehicles. It doesn't target those people who use oil to burn in industrial boilers. It doesn't target those people who use oil to burn for home heating. Therefore, it's an extremely inefficient policy because it doesn't equate the marginal cost of the policy across all uses.

A CAFE policy does not target carbon-rich fuels but only oil that is used solely in new vehicles. That can't be a very efficient way to deal with the global warming problem.

The current proposal would cost something like $17 or $18 billion a year in lost consumer surplus. That's what an economy is designed to do- to produce goods that people really want which generates surplus for them.

To the extent that we make cars less safe through CAFE people will trade off against it; that is, they will find ways to protect themselves against these awful light unsafe cars by buying more safety equipment, strapping their belts on, buying air bags, and so forth.

Plus, the latest research suggests that air bags don't improve safety. All of the surplus in increased safety is taken up by driving less safely.

Excerpts from Barry Felrice

I will talk about the promise of technology, but also the limitations of technology. When we talk about CAFE particularly as part of the current debate in the Senate, it's allegedly a technological debate. But I will argue that some of the numbers floating around are way beyond the capabilities of technology as we in the auto industry or, I think, anyone on this planet can conceive in the time frames that we're talking about.

During the time of the steep rise in gasoline prices the actual fleet CAFE increased significantly. From model year '79 till about '82 it went up from about 18 to over 25 miles a gallon. Was this due to CAFE standards? I would argue that CAFE standards were somewhat if not totally irrelevant during that period of rising gasoline prices.

And that's one of the fatal flaws of the program: that is, it assumes that we could set these CAFE standards and that they could be met through technology. Everyone thought in the mid-seventies that the real price of gasoline was going to rise. One constant in the 25 years of CAFE has been the inability of everyone, government, economists, auto manufacturers, to predict future prices of gasoline.

So when gasoline prices rise CAFE becomes somewhat irrelevant. When gasoline prices drop or steady then they become a constraint on manufacturers and on consumers and they limit consumer choice.

EPA has stated that fuel efficiency -- how much gasoline it takes to move a ton a mile down the road -- has increased by 1-1/2 percent a year for each of the last 20 years. This means there is more fuel-enhancing technology going into light-duty motor vehicles.

Why are vehicles increasing in weight again as they have since the initial downsizing of the early '80s? A lot of that is safety and not just regulatory safety improvements but voluntary safety improvements, everything from antilock brakes to side air bags to electronic stability controls and traction controls. All these things add weight.

And yet at the same time fuel economy has not suffered. Our engineers have been working like crazy to keep the fuel economy the same even in the face of all these increases in weight. Some of that technology, some of the benefits, are getting eaten up by moving more mass or providing more power because that's what customers want.

Industry needs sufficient lead time if CAFE standards are to change to get a return on our investment in technology. We spent $3 billion on the new 2002 Dodge Rams which included a new assembly plant, a new engine, and a new drive train. We probably will need six to eight years of production to make that money back and get some decent return on it.

If CAFE standards change too quickly and are too high, we will have to scrap that investment where we'll lose more money, which is hard to imagine for some of us these days. We can't get to these new levels through technology. When that happens we start cutting back on the least fuel-efficient vehicles which lessens our revenue flow so then we have less revenue to invest in new technology. It's a vicious cycle.

Some say there's a lot of technology out there that you're not putting on your vehicles that are cost-effective for consumers. I'm not sure many consumers want to wait fourteen years to get $3,000 back.

[The Kerry bill] is technologically unfeasible. We know of no basis in science, fact, data, or any report (especially the National Academy of Sciences report) that would lead one to the conclusion that the 35mile per gallon average level is achievable through cost-effective technology in that timeframe (2013). It just ain't so!

For example, let's look at Daimler Chrysler. Assume we could achieve at 28-mile-a-gallon truck fleet. For us to average 35 miles per gallon, our car fleet has to get 78 miles a gallon. Now, if those trucks only get 27 miles a gallon, then our car fleet has to get something like 111 miles a gallon.

So any law that talks about a combined standard has disparate competitive effects which I would argue, the Congress is not fully considering.

So Senator Kerry's [CAFE] bill is really not even a 35-mile-a-gallon bill by 2013. It's more like a 40-mile-a-gallon bill.

Excerpts from Sam Kazman

The debate we're seeing right now over CAFE is a fundamentally dishonest debate. Before the National Academy of Sciences issued its CAFE report this past summer I had never met a single defender of CAFE who admitted it kills anyone. Now, after that report, they still don't admit it kills anyone at all.

None of ITS defenders had ever said CAFE kills. They didn't admit CAFE kills anyone after Bob Crandall and John Graham published their 1989 study, which found between 2,200 and 3,900 deaths annually from CAFE. They didn't admit it kills anyone when, in 1999, USA Today published its extensive analysis finding over 40,000 deaths from CAFE over the lifetime of its program in 1999.

And then the National Academy of Sciences issued its report last August, which found that CAFE kills between 1,300 and 2,600 people per year due to its constraining effect on producing larger cars. But CAFE's proponents still don't admit it kills anyone at all. For that reason, the debate over CAFE is a fundamentally dishonest debate.

Why does CAFE kill? It does so because it constrains the production of larger cars and, in most modes of collision, larger, heavier cars are more protective of their occupants than are small cars.

About 50 percent of all occupant deaths occur in single-vehicle crashes. Extra mass in a car involved in a collision with a tree or a bridge abutment or a brick wall is incredibly protective. You find differences in survival rates between sub-compacts and large cars on the order of four times as great or eight times as great, a four to eight times DELETE 'THE' higher death rate in very small cars as in the larger cars. There is simply no question whatsoever that in single-vehicle crashes larger, heavier cars are safer.

The other half of all occupant deaths, however, occurs in multi-car collisions, largely in two-car collisions, and there the issue gets a little more complicated.

In multi-car collisions adding mass to your car protects you more but it does put the occupants of the other car at somewhat greater risk. And so the question is, what is the net effect?

When the two cars involved in that multi-car collision are pretty much identical, larger mass helps the occupants of both cars. When they're not identical but are still pretty similar to each other, adding mass to your car protects you. It tends to hurt the occupants of the other car, but its net effect overall is more protection, and so society benefits from added mass.

In other scenarios involving very different cars, adding mass to one car may reduce overall social safety. But whatever the multi-car effect of added mass may be, it is totally outweighed by the protection of added mass in single-car collisions. For that reason, to use the words of Dr. Leonard Evans (head of the International Traffic Medicine Association and a researcher in this issue for three decades) , CAFE kills and more stringent CAFE standards will kill even more.

What arguments do proponents of CAFE offer, especially those who want to make CAFE more stringent?

The first argument is that new technology can get us out of this bind. It can give us much higher fuel economy and improved safety. But picture such a high-tech car in your mind and then add a few additional cubic feet and a few additional pounds to that car. Make it a little bit bigger and a little heavier.

Two things happen. Once you've made it bigger, this high-tech car is a bit safer and it's also a bit less fuel efficient. In short, you've still got a tradeoff even at this incredible high-technology frontier between safety and fuel economy. And so high technology does not get you out of this bind.

Defenders of CAFE also argue that CAFE can't be deadly because, after all, it's endorsed by Ralph Nader, Joan Claybrook, and Clarence Ditlow. But long before large cars became so politically incorrect these very same folks stated very forthrightly that larger cars are safer cars. In a 1989 magazine interview in which he was asked for his advice for buying a safer car, Ralph Nader said, first buy one with an air bag and second, buy a larger car.

In 1972, Nader and Ditlow published a book called Small on Safety: A Critique of the Volkswagen Beetle. Page after page has such statements as "Small size and light weight impose inherent limitations on the degree of safety that can be built into a vehicle."

What's happened? Back then large cars were not politically incorrect. Now they are.

Why have these CAFE converts like Nader taken this view on this position? Because for them the line has been this all along: you want more safety, you need more government. You need another government regulation if you want a safer product. With CAFE all of a sudden it's exactly the opposite.

Another example of the political incorrectness of large cars and how it has skewed consumer information can be found in Consumer Reports. Every year Consumer Reports has an annual buying guide issue which includes a very extensive discussion of how to buy a safe car. You have to dig through that safety article mid-way or more to find any mention of the fact that larger cars are more safe. In some years it's not mentioned at all.

On the other hand, the auto industry probably has the most direct stake in accurately accessing vehicle crashworthiness. Go to the web site of the Insurance Institute for Highway Safety, and look under their "Tips for Buying a Safer Car". One of the very first factors they mention is that large cars are safer than small cars. You don't find it in Consumer Reports because I believe they have somewhat of a political agenda.

Proponents of more stringent CAFE standards always present the image of a Ford Explorer devastating a GEO Metro, a large SUV just killing everyone inside a subcompact when there's a collision between the two. In the words of Adrian Lund at the Insurance Institute, that is a highly unrepresentative example; the real issue isn't so much the larger size of that Explorer but the small size of that subcompact. If you want to improve auto safety you have to do something about those subcompacts.

It is instructive to look at the Ford/Firestone tire fiasco. According to a detailed report in Public Citizen last April, Ford had requested Firestone to redesign the Explorer's tires so it was more fuel efficient. Firestone attempted to do that, and the result was a defective product. Here is an example of one company in its quest for higher fuel economy producing a defective product. Yet, that was never the focus of any attention whatsoever.

No one pushing for higher CAFE admits that it kills anyone. One thing they do argue is that higher CAFE would be keep us out of all of these blood-for- oil wars. But in a sense CAFE itself is a blood-for-oil battle and it's waged not with knowing soldiers, not with a military that knows that it's being put at risk, but with civilians who have no idea that they're being put at any risk whatsoever.

What does happen when the public learns about the safety costs of CAFE? Well, lately we've seen a slew of polls about how 300 percent of the American public wants higher CAFE standards. But the questions in those polls never mention the safety issue.

Once you tell the public about the safety issue, their views about CAFE change dramatically, and that is something that folks in Congress should keep in mind. The safety issue is an issue that can change this debate as well as public opinion.

Excerpts from Dr. Montgomery

The economy is an engine for producing goods and services that consumers want. And what you've heard about so far today is exactly how CAFE standards fundamentally interfere with efficiently allocating the resources we have in order to produce the goods and services that people want. And that means they're going to be a bad idea in terms of how well the economy operates. We need to work through where those inefficiencies in the resource allocation process come from and how large they are. We should also consider other ways we could go about remedying whatever defect in the economy CAFE standards are supposed to remedy but without so much interference the economy.

So let me start by talking a bit about what the costs of CAFE standards are.

There are three kinds of costs that need to be considered. One is the cost of technical fixes - what you would do to a car in order to make it produce more fuel economy without changing anything else about it.

Second, there's the cost of what is called mix-shifting in the debate. Mix-shifting means meeting near-term standards. In particular meeting tight CAFE standards requires figuring out some way of getting motorists to buy smaller, less powerful vehicles that are inherently more fuel efficient with constant technology than larger vehicles.

And the third cost is the cost of lost performance and other attributes of vehicles which consumers show that they value by actually going out and spending more for vehicles that have these attributes than vehicles that don't have them.

All of these [costs] tend to be either underestimated or left out completely in the studies cited by proponents of CAFE standards.

I've never seen a CAFE standard proposal that took into account the fact that there's a cycle that manufacturers go through of design and tooling and production which, if interrupted, can increase costs many fold in actually getting these hypothetical technologies into vehicles. Second, there's a cost associated with mix-shifting. What are you going to do in order to meet the fuel economy standard where you simply can't get cars up to 100 miles per gallon?

Well, this does force you to price your product so that people will stop buying your high-fuel consumption vehicles like trucks and start buying your smaller, higher fuel economy vehicles instead. And, obviously this is what occurs in the industry whenever CAFE standards are binding from the first year they take effect.

What CAFE standards do is force the subsidization of unsafe purchases by causing the subsidization of purchases of these small vehicles that then get crushed when they run into anything or when something heavier runs into them.

This kind of cross subsidization, which is driven by a regulatory program, induces people to choose vehicles which would not have been their first choice if they'd been allowed to see correct market signals as to what it costs to produce those vehicles. That's why the cross subsidization produces an inefficiency in our allocation of resources within the economy.

This is basically a frustration of consumer preferences. We're not equating the marginal cost of everything that we produce. We're not equating marginal costs to the marginal value that the consumer puts on something.

Manufacturers spend a great deal of time and a great deal of money figuring out how much their customers value certain attributes in order to figure out what package to put together to make as much money as possible when they sell a vehicle. This is not something they do for PR purposes. They do it for purposes of making money. They don't it because they have a cause.

Defenders of CAFE don't take into account factors such as acceleration, what's called noise vibration and harshness, towing capacity, about driveability, and other attributes that consumers value. And all of these things tend to be affected adversely by the technologies that are generally proposed for making cars that are cheaper and have greater fuel economy.

The one that I like best is front-wheel drive. You know why there are not very many front-wheel drive pickup trucks? Because they can't tow anything and towing is an important attribute for those who purchase trucks. So if we want to pretend that trucks are really cars, then we can impose fuel economy standards that turn them into cars when you are losing something that has a clear, identifiable value in the market place that consumers reveal when they pay something for a vehicle with the characteristics it has today. So these, I think are the costs of CAFE standards.

We (Charles River Associates) put together some estimates of the cost of technology fixes. What we came up with was that a proposal for something like the 28-mile-per- gallon SUV standard that if it was implemented over a 12-year period with a careful phase-in to match the cycle of rebuild, would increase the cost of a new SUV by about 10 percent. Anything above 35 miles per gallon for new cars is hard to even conceive of over the period that we're looking at but it would add more than 20 percent to the cost of a new car. That includes both the technology fixes and the downgrading of the quality of the vehicle in the consumer's preference. It's not the hardware. It's the combination of everything that either increases the cost or increases the value of the vehicle.

So what we're talking about there is probably something like a reduction in new car sales of about 15 percent when a standard like this comes in and starts to bite.

The larger economic modeling we've done suggests that that would produce about a 10-percent drop in employment in the auto industry during the shock period.

There is clearly a shock effect in the short run.

But, remarkably, the costs we came up with were almost identical to those that Bob Crandall talked about, which was a loss of about $17 billion per year in consumer surplus from these changes.

CAFE standards are about the worst strategy you could think of if you wanted to solve any of the problems that people have talked about, as Bob mentioned, except envy. Because it is true that CAFE standards would do something about the fact that some people have a lifestyle campaign to prohibit SUVs in the guise of fuel economy standards.

The problem with applying this only to new cars is that it certainly has the effect that I just talked about on new car sales but that's not just bad for oil companies and bad for autoworkers. It's actually bad for consumers and it's particularly bad for the environment.

First of all, it means that a large part of the fuel savings you would expect from CAFE standards go away because, what happens if people don't buy new cars? The first thing that happens is that they keep their old cars longer. Even today old cars get worse fuel economy than new cars, so delaying the replacement of old cars by new cars takes back some of the fuel economy improvements.

With CAFE standards we're also imposing on people higher fuel economy in their new cars than they would have chosen. What's that mean? Since they're not paying a higher price for gasoline, better fuel economy means it costs less to drive so people will drive more. There's another take-back effect, the additional driving that's stimulated by the CAFE standard.

So here we have two effects which I would call new-source bias. And basically the liberal environmental bias in environmental policy is let's require new sources of pollution, that is, new investment that makes the economy grow, pay considerably higher costs than what's out there already. That discourages new investment. In this case it discourages replacing older, dirtier cars with new cars and it encourages actually driving cars more. That only defeats the purpose of CAFE standards.

Furthermore, the take-back effect of lower new car purchases, slower turnover of the fleet, on fuel consumption is not very large, but it's huge on air pollution because the difference between a 10-year-old car and a new car on air pollution is immense compared to the difference in fuel economy between a 10-year-old car and a new car. So, in addition to killing people in accidents , what the CAFE standards do is that they kill people through higher levels of urban air pollution because that's what you get out of this new source bias and reduced turnover of the fleet.

Conclusion

Thank you to panelists and audience.