Hybrid Cars, or, Why Environmentalists need Economists
Some time ago, an acquaintance related a story to me that captures a lot of the thinking in environmental circles. Forgive me all the details, but it apparently happened something like the following. She was in an environmental engineering course, and the professor invited in a mid-level executive from Ford to speak with the class. When the time came for questions, one of the other students took the opportunity to ask the executive how long Ford had known how to make hybrids and been sitting on the technology. This was said with the implication that Ford was being environmentally irresponsible by not bringing hybrids to market sooner. The Ford executive was somewhat flustered, and wasn’t able to respond with anything more than a contrived and tangental answer.
The story has all the elements of a classic environmental tale: the David-versus-Goliath nature of the interaction between the student and a representative of Ford; the evil corporation ignoring environmental concerns; the notion that if we just did this, or this, then our problems would be solved; and so on. Unfortunately, one of the elements is that it shares with many other streams of thought in the environmental community is that the speaker hadn’t bothered to understand the underlying forces at work. He seemed to impress the person who related the story to me, but had the executive been on his toes at all, a far more valuable conversation could have ensued.
The problem with hybrids is threefold: the demand is still more for power than fuel economy, there’s a bit of an elasticity effect that reduces the amount of fuel saved from hybrids being on the road, and hybrids “cover” for gas guzzlers under the Corporate Average Fuel Economy (CAFE) standards.The first problem with hybrids is exactly what the Ford executive should have pointed out to the young man asking the question. Simply put, customers want faster cars more than they want cars with better fuel economy. Given their other desires (wanting a relatively large car, etc) and the fact that they have a limited amount of money to spend, fuel economy takes a back seat. This has two implications. First, the lack of demand for high-efficiency automobiles up until this point is exactly why Ford shouldn’t have been building them. Asking a struggling automaker why it isn’t making even more cars that nobody wants is like asking a man bleeding from a gunshot wound why he doesn’t feel like hunting today. Second, hybrid technology increases the efficiency of a car– it allows the car to produce more useful power from a gallon of fuel. This can be used in one of two ways: it can be used to raise the car’s gas mileage, or it can be used to make the car more powerful. There’s reason to believe that those hybrid tax credits might not all be going toward reducing greenhouse gas emissions. Consider the 2007 Lexus GS 450h. It’s not out yet, but notice that the advertising isn’t as concerned with the fuel economy as it is with the 300hp engine/motor combination.
The second problem with hybrids is a much less important one, but one that is still worth mentioning. Demand elasticity exists, and it matters. Just as people tend to drive less when gas is more expensive, they tend to drive more when it’s cheaper. The same phenomenon applies when a car gets better fuel economy. Because the incremental cost of driving an extra mile is lower with a hybrid, that mile gets driven more often. This doesn’t negate the clean-air benefits of hybrids, but it does reduce it to less than what one might expect.
The third problem received a mention in the New York Times recently. Namely, for every super-efficient hybrid sold, an extra gas guzzler can be produced and sold without penalty. CAFE works based on fleet averages– so, for example, that Ford Escape hybrid you bought just lowered the fleet average just enough for an extra Navigator to be produced without any concessions to efficiency. Or, to put it more dramatically, the hybrids are subsidizing the Hummers.
These aren’t problems with hybrids per se, they’re rather problems with the incentive structure that’s currently in place. Watch what happens when, instead of placing our faith in technology and railing against corporate giants, we play economist and adjust the incentives by replacing CAFE with a gas tax… The first problem disappears, as the cost of a gallon of gasoline has increased substantially. Sure, everyone wants power, but they also want a flat-screen TV, and they can’t afford both. The second problem is no longer really a problem– it’s the phenomenon we’re using to our advantage. An individual with a more efficient car can certainly afford to drive a little more than one without, but this is occuring in a situation in which everyone– including the hybrid owners– is driving less. Finally, since CAFE doesn’t even exist, and it’s been replaced with Hummer owners paying the real cost of driving those vehicles, the third problem vanishes as well.
I don’t know who the student was who asked the question of the Ford executive, but I hope he learns the power of incentives, and how important the economics of environmental issues can be. New technologies can be great, but they exist in a larger context, one that is defined by market forces and politicans who set the rules of the game. That Ford executive didn’t deserve a grilling for his company’s decision not to bring hybrids to market sooner, he and his company are just playing the game as best they can. In other words…
Don’t hate the player, hate the game.