Auto Industry: Regulation as Stimulus

by: Ryan Avent

Today's biggest economic news is actually being made by the EPA. The agency will declare today that carbon dioxide poses a public health threat, and that tailpipe emissions contribute to climate change. That finding sets the stage for EPA regulation of CO2 emissions.

As Brad Plumer says here, it's difficult to overstate the importance of this result. It means that the United States will take action to reduce emissions, no ifs, ands, or buts about it. The big question is how this action will be taken. The most common interpretation of the dynamic is that the EPA's ability to regulate CO2 will light a fire under legislators to get something done. Congress wants to be in the room when the rules are made, and to do that, they need to convince the agency that they'll actually get a bill through both houses in a reasonable time frame.

But the EPA may not wait too long to take some steps. A ruling on motor-vehicle emissions is the most likely first step. Even if regulators wait on producing rules for fixed-point emitters, like power plants, some impacts could be felt relatively immediately. A higher probability of strict climate change regulation will alter the calculus on Wall Street, making it more difficult and expensive for fossil fuel plants to obtain financing, and easier for alternative generators to get investment capital.

The common industry line on all of this is that new carbon regulations will be bad for the economy. The common environmentalist reponse is that 1) no it won't, and 2) climate change will also be bad for the economy. But I think there's another potential interaction between regulation and economic growth. A while back, responding to questions about how we'd get out of this economic mess if all policy initiatives failed, Paul Krugman described the "spontaneous remission" of recessions:

[R]ecovery comes because low investment eventually produces a backlog of desired capital stock, through use, delay, and obsolescence. And eventually this leads to an investment recovery, which is self-reinforcing.

And what do we mean by use, delay, etc.? Calculated Risk had a nice piece on auto sales, which I find helps me to think about this concretely. As CR pointed out, at current rates of sale it would take 23.9 years to replace the existing vehicle stock. Obviously, that won't happen. Even if the desired number of vehicles doesn't rise, people will start replacing vehicles that wear out (use), rust away (decay), or just are so much worse than newer models that they're worth replacing to get the spiffy new features (obsolescence).

As autos go, so goes the capital stock. In the long run, we will have a spontaneous economic recovery, even if all current policy initiatives fail.

A new carbon regulatory regime could basically act to accelerate obsolescence of dirty technologies. Consumers and businesses would be encouraged to scrap less efficient machines and invest in cleaner automobiles or homes or appliances sooner. Given the slack in the economy at the moment, it would be all to the good if everyone decided that now was a good time to start preparing for a world in which carbon costs money. It's regulation as stimulus.