Fuel taxation, emissions policy, and competitive advantage in the diffusion of European diesel automobiles

• Author: María J. Moral,Jeff Thurk,Eugenio J. Miravete
• DOI: http://doi.org/10.1111/1756-2171.12243
• Published date: 01 September 2018
• Date: 01 September 2018

RAND Journal of Economics

Vol.49, No. 3, Fall 2018

pp. 504–540

Fuel taxation, emissions policy,

and competitive advantage in the diffusion

of European diesel automobiles

Eugenio J. Miravete∗

Mar´

ıa J. Moral∗∗

and

Jeff Thurk∗∗∗

Economic integration agreements have significantly decreased import tariffs. We investigate

whether national policies can be an effective replacement for tariffs to protect domestic industry.

We show that (a) European fuel taxes and vehicle emissions policy favored diesel vehicles, a

technology popular with European consumers but largely offered only by domestic automakers;

(b) European automakers benefited frompro-diesel fuel taxes and a lenient NOxemissions policy

to earn significant profits from diesel cars; and (c) that both policies amounted to significant

nontariff trade policies equivalent to an import tariff between two to three times the official rate.

1. Introduction

Multilateral trade agreements among countries have driven import tariffs to historic lows

(Bergstrand,Larch, and Yotov,2015). When application of traditional protectionist policies such as

tariffs and quotas becomes harder due to trade liberalization agreements, governments may resort

to less obvious regulations designed to protect domestic industries (Bhagwati and Ramaswami,

1963; Staiger, 1995; Bagwell and Staiger, 2001; Ederington, 2001). In this article, we consider

∗The University of Texasat Austin, Centre for Competition Policy/UEA, and CEPR; miravete@eco.utexas.edu.

∗∗UNED, Paseo Senda del Rey, GRiEE and GRIPICO; mjmoral@cee.uned.es.

∗∗∗University of Notre Dame; jthurk@nd.edu.

This article supersedes “Protecting the European Automobile Industry through Environmental Regulation: The Adoption

of Diesel Engines.” Wethank the Editor, AvivNevo, and the three referees for outstanding comments and suggestions. We

are also grateful to Kyle Bagwell, Allan Collard-Wexler, John Graham, Kenneth Hendricks, TomHolmes, Cristian Huse,

Ashley Langer, Amil Petrin, Jeff Prince, Bob Staiger, Frank Wolak, as well as seminar audiences at CCP/East Anglia,

CESifo/Munich, Collegio Carlo Alberto, Colorado, Duke, Ford Motor Company, DG Competition-EU, Florida State,

ICESI, Indiana, ITAM, Michigan, National Singapore University, Pablo de Olavide, Pontificia Universidad Cat´

olica de

Chile, Texas-Austin, Wisconsin-Madison,Vigo, Yale, Zurich, the 2013 Economics of Low-Carbon Markets conference

in Riber˜

ao Preto, the 2015 CEPR Conference on Applied Industrial Organization in Athens, the 2014 Hal White Antitrust

Conference in WashingonDC, the 2015 Barcelona GSE Summer Forum, the 2016 SITE-Trade and SITE-IO meetings in

Palo Alto, the 2016 TE3 conference in Ann Arbor,and the 2017 ITEA Conference in Barcelona. We are solely responsible

for any errors that may still remain. Moral gratefully acknowledges funding from the Spanish Ministry of Education and

Science, and the European Regional Development Fund through grants ECO2017-82445-R and ECO2015-69334.

504 C2018, The RAND Corporation.

MIRAVETE,MORAL AND THURK / 505

fuel taxation and vehicle emission regulations as examples of such policies employed by the

European Union (EU). Weargue these policies had the effect of promoting diesel vehicles among

consumers and thereby increased profits for the firms who offered diesels—European automakers.

Our setting is the European marketplace where (largely) European diesel vehicles constitute

the majority of new car sales. Weshow that diesel fuel was taxed at a lower rate than gasoline and

the vehicle emissions policy chosen by European regulators targeted carbon monoxide (CO) and

carbon dioxide (CO2) but not nitrogen oxide (NOx).1This distinction is important, as diesel cars

produce a large amount of NOxemissions but relatively little CO and CO2. Gasoline-powered

engines do just the opposite. Hence, these policies provided a competitive advantagefor domestic

automakers, as foreign firms sold gasoline-poweredvehicles which not only used a more expensive

fuel, but also faced stricter emissions standards than their diesel-powered competition.

We use detailed automobile registration data from Spain—a country with diesel adoption

rates representative of Europe—to estimate a structural discrete-choice oligopoly model of hori-

zontally differentiated goods similar to Berry,Levinsohn, and Pakes (1995), henceforth BLP.The

model is flexible enough to generate reasonable substitution patterns between similar products

and account for product characteristics known to consumers and firms but not to the researcher.

Our data have two important features. First, the sample covers the years immediately following

the introduction of the turbodiesel engine in 1989—a major improvement in diesel technology,

which proved to be very popular among consumers, as diesel penetration increased from 10% to

50% in less than a decade. Second, the sample also coversa period in which European automakers

faced increased competition from Asian automakers.

We show that fuel taxation and vehicle emissions standards chosen by European regulators

promoted diesels through three channels. The first channel is consumer demand, where our

estimates indicate that consumers preferred vehicles with greater fuel economy, defined as the

number of kilometers one can travel per euro of fuel. Fuel economy is therefore a function of

both fuel efficiency, defined as the number of kilometers one can travel on a liter of fuel, and

fuel price, where the latter is impacted by fuel taxes. A primary advantage of diesel cars is their

superior fuel efficiency, traveling 20%–40% farther on a liter of fuel. Because they benefited from

preferential European fuel taxes, the average diesel in our data could travel 63% farther per euro

of fuel relative to a comparable gasoline-powered car. A stricter vehicle emissions policy would

have eroded this advantage, as the addition of sophisticated abatement technologies required to

meet such a standard would have increased vehicle weight and decreased performance. These

two policies, therefore, both worked to promote diesel vehicles by enhancing the fuel savings of

diesels’ superior fuel efficiency.

The second channel corresponds to the increased marginal cost required to meet a stricter

NOxemissions policy. We document several different technologies capable of reducing NOx

emissions, though each increases production cost to diesel vehicles. In equilibrium, some of this

expense would have been passed on to consumers through higher retail prices, leading some

consumers to switch to models equipped with gasoline engines likely produced by foreign firms.

By not choosing stricter NOxemissions standards, European regulators implicitly reduced the

retail prices of diesel vehicles and increased the likelihood price-sensitive consumers would

choose them.

The third channel addresses why these policies amounted to nontariff trade policies. We

argue that the popularity of diesel cars among European consumers is a unique feature of this

market, and we outline a variety of initial conditions which likely provided a foundation for

the fast adoption of diesels in Europe. As the European market constituted the bulk of sales

for domestic automakers, developing a viable diesel technology was a worthwhile investment.

Foreign firms, on the other hand, chose not to invest in the diesel technology because Europe

1CO and CO2are greenhouse gases associated with global warming, whereas NOxemissions are associated with

smog and to a lesser extent, acid rain. The role of CO as a greenhouse gas is weaker than CO2, though still relevant(see

tes.jpl.nasa.gov/mission/climateroles).

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506 / THE RAND JOURNAL OF ECONOMICS

constituted just a niche market for them.2Policies favoring diesels thus benefited domestic firms

almost exclusively.

Wequantify the effects of alternative fuel taxation and vehicle emissions policies via counter-

factual analysis. Weshow that diesels were not only popular among consumers, but also generated

significant profits for European firms. Had regulators imposed fuel taxes and vehicle emissions

standards which did not favor diesel vehicles, consumers wouldhave substituted toward gasoline-

poweredAsian impor ts, leading to significant reductions in profits for domestic automakers. Such

a shift is usually achieved by levyingimpor t tariffson foreign products, leading to less consump-

tion of foreign varieties. Multilateral negotiations over the past several decades, however, have

driven import tariffs to record lows, thereby reducing their effectiveness as a policy tool.

Weuse the estimated model to measure the implicit protective value of these policies, that is,

their tariff-equivalence. We find that only by imposing an import tariff of between17.1%–27.4%,

or roughly two to three times the official rate, could European regulatorshave both employed the

alternative policies we consider and maintained the import share observed in the data. Moreover,

we show both policies played important roles in protecting domestic firms. We view these results

as evidence that national policies can indeed amount to significant nontariff trade barriers.

Economists, policy experts, and politicians have all expressed concerns over the ability of

national policies to fill the void left by import tariffs, but identifying and quantifying effects of

nontariff barriers (NTBs) has proven difficult. Our results, therefore, amount to an important and

novel contribution as, to the best of our knowledge, this study is the first to measure the effects

of a NTB using an estimated structural model. The advantage of our structural approach is that it

enables us to account for the optimal equilibrium responses of consumers and firms to alternative

policies, thereby increasing the reliability of our conclusions.

Weare not the first to evaluate the trade effects of policy on heterogeneous firms in the auto-

mobile industry. Feenstra (1988) documents that voluntary export restraints placed on Japanese

cars during the 1980s and early 1990s induced significant quality-upgrading by Japanese firms,

leading to the growth of luxury brands Acura, Infiniti, and Lexus in the US market. Berry,

Levinsohn, and Pakes (1999) show this policy also increased profits for domestic firms and

decreased welfare for domestic consumers, although left significant tariff revenue on the table.

Goldberg and Verboven (2001) evaluate sources for cross-country dispersion of vehicle prices in

Europe prior to 1993, whereas Goldberg and Verboven (2005) document that the creation of the

European single market served to reduce price dispersion. Put differently, these articles document

that the existence of different rules among European countries served to decrease competition.3

Our contribution is to evaluate the tariff-equivalenceof domestic policies and thereby demonstrate

that seemingly innocuous domestic policies can amount to significant trade policy.

Weshow our results are robust to a variety of alternative assumptions, and that European firms

would have had to increase the fuel efficiency of their gasoline fleet significantly to compensate

for lost diesel profits under the alternative policies we consider. At the core of our hypothesis is

the idea that national governments may set seemingly innocuous rules which benefit domestic

firms at the expense of foreign ones. It is from this perspective that Volkswagen’s (VW) recent

admission to cheating on the US Environmental Protection Agency’s NOxemissions standards

provides a unique external validation for our conclusions.4

2Kato (1997) recognizes the priority given by European regulators to CO2over NOx, as well as the disinterest of

Japanese firms to invest in an automobile technology (diesels) that waspopular only in Europe. Busser and Sadoi (2004)

document that because demand was small in their countries of origin, Asian manufacturers such as Toyota chose to

purchase diesel engines from other European firms as a less costly way to satisfy European demand rather than investing

in the development of diesel engines from scratch.

3Jacobsen (2013), Goldberg (1998), and Ito and Sallee (2018) show the introduction of corporate average fuel

economy (CAFE) standards in the United States favored foreign over domestic firms. Thus, the domestic policy they

study actually promoted foreign imports.

4On September 18, 2015, the US Environmental Protection Agency (EPA) accused Volkswagen of devising a

sophisticated scheme to deceive authorities when testing for nitrogen oxide(NO x) emissions.

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