99/00828 Why CAFE worked

Abstract

The frequently controversial Federal Automotive Fuel Economy Standards (a.k.a. Corporate Average Fuel Economy (CAFE) standards) have in fact been a notable success. This paper attempts to explain why the CAFE standards have been such a successful energy policy. It begins by demonstrating that economic theory does not relegate technology standards to permanent second best status. As a public policy aimed at correcting an externality, regulations can be the key part of a first best public policy response. To be sure, practical problems will arise in implementing either an effluent tax or a regulatory standard. Next, it is argued that in the oligopotistic automotive market a combination of satisfying behavior on the part of consumers and risk aversion on the part of producers makes it very likely that fuel economy standards will be more effective than even a motor fuel tax. This does not mean that gasoline or vehicle use taxes are not important or useful policy tools. Indeed, they are essential if policies are to be economically efficient. It means that taxes will be most effective and efficient if used in conjunction with fuel economy standards.