WP-012: Koichiro Ito and James M. Sallee, "The Economics of Attribute-Based Regulation: Theory and Evidence from Fuel-Economy Standards" (December 2015)
This paper sheds light on the impact of attribute-based regulation, in which regulatory compliance depends upon some secondary attribute that is not the intended target of the regulation. For example, in many countries fuel-economy standards mandate that vehicles have a certain fuel economy, but heavier or larger vehicles are allowed to meet a lower standard. Attribute-basing is designed to provide a weaker regulation for products or firms that will find compliance more difficult. This can both improve equity and enhance efficiency by equalizing marginal costs of compliance across firms, but it generally comes at the cost of distortions in the choice of attribute upon which the regulation is based. An example is the new Corporate Average Fuel Economy (CAFE) Standards in the United States, where fuel-economy standards depend on the footprint of the vehicle. A related example is Japanese fuel-economy standards, under which fuel efficiency regulation varies based on the weight of the vehicle. That is, heavier vehicles are subject to lower fuel efficiency requirements.
With data from the Japanese vehicle market covering 10 years and two regulatory changes, Koichiro Ito and James Sallee show that attribute-based standards do create large distortions in vehicle weight in the Japanese automobile market. Automakers have a large incentive to increase the vehicle weight only up to key thresholds where the mandated fuel economy drops discretely. The data demonstrate that there is significant “bunching” in the distribution of vehicle weight around the regulatory thresholds, which reveals strong evidence of weight manipulation in response to the policy. The researchers found that 10% of Japanese vehicles have had their weight increased in response to the policy. For those vehicles, the average weight increase induced by the regulation was 110 kg, which is about a 10% increase in vehicle weight.
In addition to new fuel-economy thresholds in 2009, the Japanese government introduced separate subsidies that applied to each specific car model. Consumers that purchased cars that met the new fuel-economy standards in advance of the required date and/or cars that had fuel efficiencies greater than the new standard received financial subsidies. The vehicle-specific subsidies created a “double notched” policy. The authors found that the vehicles that gained the subsidy were usually modified so that they were just above the eligibility cutoff and most cars increased both weight and fuel economy in order to become eligible for the subsidy.
In order to estimate the societal and policy implications of attribute-based regulations, the authors simulate three alternative policy scenarios: attribute-based fuel economy standards, a flat standard without compliance trading and a flat standard with compliance trading, which is theoretically equivalent to the most efficient policy. Their simulation highlights several key policy implications. First, the fully efficient policy provides an energy-efficiency improvement in the most cost-effective way, which is consistent with their theoretical findings. Second, the attribute-based policy creates substantial distortions in the attribute (vehicle weight), which accounts for 30% of the total regulatory cost of the policy. Third, attribute-basing also provides a potential benefit relative to a flat standard without compliance trading because attribute-basing partially harmonizes the marginal costs of compliances. Finally, the attribute-based regulation is nevertheless an inefficient substitute for a fully efficient policy such as a non-ABR policy with compliance trading because the efficient policy does not create attribute distortions and fully equalizes the marginal costs of compliance.