The 1973 Yom Kippur War pitting Israel against Syria and Egypt motivated an Arab petroleum boycott, instigating congressional passage of the 1975 Corporate Average Fuel Economy standards. Known by its acronym, CAFE, the program does not mandate that every car sold in the United States be parsimonious but defines an average that each manufacturer’s cars must attain.
At the time, Republican and Democratic commentators anticipated both major and collateral benefits. First, cars burning less fuel would reduce dependence on petroleum imports from potentially hostile nations. Second, CAFE would force domestic manufacturers to devote a higher percentage of output to small cars, curtailing loss of domestic automobile sales and jobs to imports. In 1975 hardly anyone had heard of global warming or worried that carbon dioxide emissions might pose a threat to human welfare, but it seems obvious that reducing petroleum consumption would reduce carbon emissions from that source.
Whatever one’s view of the merits of the triad — reducing imports of foreign petroleum, curtailing substitution of foreign for domestic automobile production, reduction of carbon dioxide emissions — CAFE defined an excessively costly path toward those goals and led to perverse unintended consequences. Congress ignored people’s predilections to seek alternative ways to satisfy legislatively discouraged preferences. A more successful and less costly approach would merely define goals, use prices to properly align private incentives with those goals, then permit individuals to determine how best to make whatever adjustments they deem desirable.
Congress recognized that GM, Ford, and Chrysler each engaged in substantial automobile production abroad. Indeed, at that time, Ford, not Toyota or Volkswagen, was the largest car producer outside the United States. Gasoline taxes and hence retail prices throughout the rest of the developed world were a multiple of those in North America, while streets were narrow and parking scarce. Therefore, like the distribution of output of foreign manufacturers, the Big Three biased their offshore production toward the small cars that most foreign buyers wanted.
Congressional fear that the Big Three would meet CAFE requirements by increasing imports from their offshore operations led to the definition of separate pools — in order to avoid substantial fines, a producer had to satisfy the miles per gallon standard for one pool of domestically produced automobiles and separately for a distinct pool of those from abroad. Vehicles defined as light trucks soon became a third pool, with more lenient standards than are imposed on cars. Perversely, the distinction between light trucks and cars did not hinge on function or appearance, but on vehicle weight — once a model’s weight (and thus its fuel consumption) became high enough, it became a “light truck” ruled by more forgiving CAFE standards.
The initial impact of CAFE on domestic producers was straightforward: to satisfy the mandates, they had to produce fewer large cars and more small ones, artificially increasing the prices of large domestic cars and decreasing the prices of competing small, imported models.
Almost exclusively, foreign companies had been exporting small cars to the United States and had no difficulty in meeting CAFE standards. In 1983, for instance, domestic production (at 24.4 mpg) failed to meet the CAFE standard (26.0 mpg) but imports easily exceeded the mark (32.4 mpg). Given the constrained ability of domestic producers to compete in one segment, the imports soon recognized the attraction of designing larger cars than were demanded in their home markets in order to reap the increasing large-car profit margins in the United States.
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