Unintended Consequences of Government Involvement in the Auto Industry

Government incentives play a large role in the auto industry. The 2022 Inflation Reduction Act (IRA) has been making big waves in the auto industry, not only in the U.S. but around the globe. The IRA established incentives designed to encourage the sale of electric vehicles (EVs) and the use of domestic parts and materials throughout the automotive industry, including a new clean vehicle tax credit of up to $7,500. However, the government is providing tax credits for even more incentives within the supply chain, such as a 10% tax incentive for mining critical minerals and up to a $35 tax credit for every kWh of energy produced from a battery. The incentives subsidize the industry top-to-bottom with billions of dollars. Injecting money into cutting edge technology is great, right? What could go wrong with the government intervening in the market?

Developed to support environmental and economic objectives, government interventions in the auto industry mean well, but have often resulted in unintended consequences. Two notable examples are the Cash for Clunkers program and the Corporate Average Fuel Economy (CAFE) standards. While both initiatives were designed with positive intentions, negative impacts have occurred on both the new and used auto markets as a result.

Remember the Cash for Clunkers program? Implemented in 2009 and officially known as the Car Allowance Rebate System (CARS), the program offered financial incentives to consumers who traded in older, less fuel-efficient vehicles for newer models. As a result, new car sales increased, and less efficient vehicles were removed from the road. However, this substantially distorted the used car market. Many vehicles traded in were still very functional and could have been resold in the used car market. However, per the program’s requirements, these cars were destroyed. This reduced the supply of affordable used cars which disproportionately affected low-income individuals. It also contributed to an inflation of the new vehicle market further pricing low-income individuals out of the market. 

Ever wonder why you see fewer and fewer sedans on the road? Have you noticed vehicles seem to be getting bigger and bigger? The CAFE standards passed in 1975, have had continued unintended consequences on production of new vehicles since its inception into the present day. Fuel economy targets were tied to weight and wheelbase, not the type of vehicle. As a result, SUVs and trucks were held to a much lower standard and manufacturers have prioritized the production of trucks and SUVs over smaller, more fuel-efficient vehicles. The auto industry innovated a way out of the fuel efficiency problem—in lieu of building more efficient, smaller vehicles, the focus shifted to the production of larger vehicles which are held to much lower standards. This trend has not only impacted fuel efficiency and cost, but also safety, as larger vehicles tend to have more mass and may pose greater risks to other road users in the event of a crash.

History is poised to repeat itself. The IRA aimed at incentivizing EVs in the United States carries the potential for consequences unknown at the time. Do we have the production, electrical and charging infrastructure for this change? Are people ready to give up their gas vehicles for a full EV?  The answers are becoming clear. 

The production supply chain is already strapped to the max and is an arms race to get the necessary materials for facilities and batteries. Auto makers are fighting each other to take advantage of the incentives and capture the market. The power grid is also not ready for the influx in power consumption.  The timing of phasing out coal plants and phasing in EVs is the perfect storm. With increased warnings of rolling blackouts, coupled with aging electric infrastructure, how do we manage to increase power production while distributing the current demand?

We are also starting to see stories of stranded EV owners in cold winters, the high cost of battery re-placement, range anxiety—an EV driver’s fear that a vehicle has insufficient energy storage to complete a trip—and no way to recycle used batteries economically. Some hear these stories and believe hybrid vehicles could be key in the transition to electrification. Hybrids serve as a bridge between traditional internal combustion engine vehicles and fully electric models, offering consumers a familiar driving experience with improved fuel efficiency. Hybrids would solve the range anxiety, reduce the financial impact for battery replacement and recycling and be a smooth transition to full EVs.   

My point is, let’s take a step back and critically look at what effect the legislation is having on people, investments and the market in real time and make the necessary adjustments to achieve our goals. As with CAFE and Cash for Clunkers, the unintended consequences are not showstoppers. However, instead of legislating and walking away, we need to take stock of the evident consequences and adjust to serve for all—local, national and global populations. How do we prioritize grid infrastructure investments and energy production in an intelligent way? How do we augment the IRA to incentivize a logical progression to the end game of EVs without stepping around or over logical options like hybrids?  The answers to those questions will take community and industry consensus to implement real value-added programs and initiatives.