Regulation or Market Process

The current CAFE standards regulating fuel efficiency expire in 2016. The president's administration is currently working on proposals which will extend these over the next horizon and make them even stricter.

However, for you and me, the real reason that we are conserving on fuel and looking for more efficient cars is because the price of gas is rising. The quick knee-jerk market reaction here is to claim that the market is the side that binds and drives progress.

My first reaction is one of public choice: Politicians are just taking credit for something that is occurring anyway. But then, I think a bit more about the problem. Oil prices would not be so low if there were not so many subsidies for fossil fuel, and so many other programs which allow the industry to sell oil at prices below cost. The President seems to understand the need to deregulate, but why am I sure that this will never happen?

Instead of subsidies for alternative energy, we can remove the subsidies for oil which counteract the incentive for supply side research by keeping quantity demanded of oil higher. By allowing oil prices to rise, the search for alternatives follows the market path of substitution given movements along the demand curve consistent with higher prices and lower quantities demanded of the good in shorter supply and higher quantities demanded of the alternative good.

What the government policy is doing is not only taking credit for what is occurring, raising CAFE standards as oil prices rise, but it is also interfering with the market for alternatives. I think that were the government to take a neutral position on transportation energy we would see far more change in how we drive than we are currently seeing. I argue then, that they are both taking credit where credit is not due as well as not taking blame for mucking up the signals between alternative goods so that the evolution of technology in transportation is slowed.

Predictably, I have faith in a market process approach. Rather than love the market when it makes you look good and muck it up behind the scenes to justify continued intervention, maybe we should simply remove the "quasi-" part of the quasi-market solution and reap the rewards of private incentives before we burn another decade's worth of petroleum at ever increasing prices.