How to incentivise the transition to electric vehicles
One thing economists understand is that change only happens when people have an incentive to change. And when it comes to fighting climate change, getting the incentives right is crucial, because unlike in many other instances, we do not get a second chance. There is no spare Earth we can go to if we break this one.
As a believer in human ingenuity, I think that incentives should be set in such a way that they give people the biggest leeway to figure out a solution to an existing problem. This is why I am all for putting a price on carbon in the form of emission trading schemes for example because it internalises the cost of carbon and lets businesses figure out the best way to reduce their carbon emissions themselves. In Europe, the Emission Trading Scheme put in place in 2005 has been quite successful in getting utility companies and other heavy polluters to reduce their carbon footprint. In fact, the scheme was so successful that in the European Union every sector now has declining CO2 emissions, bar one: CO2 emissions from transportation continue to increase every year.
To be more precise, 44.5% of CO2 emissions in the European Union are caused by cars. Our never-ending love for SUVs and other big cars means that we keep emitting more and more CO2. But there is hope. Hybrids and electric vehicles are becoming more popular as the cost of batteries drops. However, the adoption of electric vehicles is slower than what one would expect from the declining prices of electric cars. So how can we incentivise people to buy more electric cars?
The spontaneous response of politicians is to mandate car manufacturers to build more electric cars or to introduce subsidies for electric cars. The idea is that car manufacturers have to ensure that a certain percentage of all the cars they sell are electric so that these vehicles are effectively pushed into the market. Alternatively, the government could provide subsidies to people who buy an electric car in the form of tax breaks. Another measure that is typically only considered a supporting measure is to gradually increase fuel-efficiency standards to make conventional cars more efficient.
I never was a fan of so-called portfolio mandates that require car manufacturers to sell a certain number of electric vehicles simply because that is too close to a planned economy for my taste. After all, the easiest way to sell a certain number of electric vehicles is to produce the cheapest and crappiest electric cars possible and then sell them at discount prices. The result is a fleet of horrible cars on the road. If you have ever driven a Trabant built in the German Democratic Republic, you know what I mean.
Instead, I was in favour of government subsidies to buy electric cars together with fuel-efficiency standards to reduce the carbon footprint of conventional cars. But it seems I was only half right. A new study by Christina Littlejohn and Stef Proost modeled the cost and impact of different incentives for the transition from conventional to electric cars. They looked at the cost and impact of mandates for car manufacturers to change the portfolio of the cars they sold, government subsidies to buy electric cars and fuel efficiency rules. And to my surprise, it seems that fuel efficiency standards seem to be the single most effective tool to change the carbon footprint of cars. The chart below shows the impact of the three different incentive schemes on the carbon emissions of cars and the associated costs for the economy. While portfolio mandates would reduce carbon emissions a little bit more than fuel efficiency rules and subsidies, the costs to society are much higher. In fact, the reduction in CO2 emissions from improving fuel efficiency standards is only a little bit less than the reduction from subsidies or portfolio mandates, but the costs associated would be much lower.
Cost and effectiveness of different incentive schemes to reduce carbon emissions of cars
Source: Littlejohn and Proost (2019).
In a sense, fuel efficiency standards act like carbon emission trading schemes for utility companies. Everybody is free to do whatever they want as long as they pay for the carbon they produce. Car manufacturers have the leeway to choose the best way to reduce carbon emissions, whether that is by producing electric cars or switching to hydrogen-powered cars or to build combustion engines that are twice or three times as fuel-efficient as current engines. I am fine with any solution as long as the carbon emissions decline.
Unfortunately, not everyone seems to think like that since the current US government tries to lift existing fuel efficiency standards in the US. So, while I may have been only partially right in my views to reduce carbon emissions of cars, the US government is exactly wrong in its views.