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OECD paper presents and analyzes policies and programs to foster market growth of green cars

24 September 2012

Oecd
Timing and sequencing of energy technology policy. Source: OECD. Click to enlarge.

While alternative fuel vehicles can potentially provide an important contribution to reducing greenhouse gas (GHG) emissions and threats to air quality and human health; enhancing the energy security of countries; and providing governments with new sources of economic growth and competitiveness, there are a number of specific barriers retarding the development of the market, according to a detailed policy paper newly published by the OECD as part of its “Green Growth” series. (The OECD, the Organisation for Economic Co-operation and Development formed in 1960 when 18 European countries plus the US and Canada joined forces to create an organization dedicated to global development. Today, the OECD has 34 member countries.)

Given the specific barriers, suggests author Andrea Beltramello, there is a role for government to support the development and diffusion of green vehicles, including through policies to strengthen the markets for green cars. However, he writes, the use of targeted policy intervention raises a number of challenges related to the timing and level of support; the choice of appropriate policies and fuels/technologies that should be supported, and the inherent risks.

The paper, “Market Development for Green Cars”, presents and analyses policies, programs and approaches for the development, market introduction and diffusion of green cars (primarily from the demand (pull) side). It also reviews government policies in a number of OECD countries as well as a selection of non-OECD economies.

Although green cars are generating increasing interest among policy makers, businesses and consumers, their economic and environmental benefits are still uncertain. Several factors are slowing the development of the market, especially of the more radical alternatives such as battery electric vehicles (BEVs). These include: the high price of green cars relative to conventional petrol- and diesel-fueled vehicles; the lack of refueling/charging infrastructure; the restricted driving range compared to conventional vehicles, and the perceived distance needs of consumers, which often do not correspond to their regular driving habits; as well as refueling times that are longer than what consumers are accustomed to. In addition, high entry barriers favor incumbent firms and technologies over newcomers. Nonetheless, innovative business models are emerging, and play a fundamental role in determining the success of green vehicles.

...Identifying a market for green cars and analyzing its developments present some daunting challenges. First, the very concept of a market for green cars is difficult to pin down, due to the existence of separate and competing technology trajectories. Second, the economic and environmental benefits of green vehicles are still very uncertain, and this leads to difficulties in appraising the potential market outlook. Several factors are slowing down the development of the market, and the deployment of green vehicles currently seems to be following the more conservative estimates.

...“Green cars” can be defined as vehicles that use alternative fuels (other than petrol or diesel) and/or alternative types of propulsion (other than the conventional ICE). Alternative fuels include biofuels, natural gas, hydrogen and electricity from the grid. Alternative propulsion systems include hybrid and electric engines. It would be misleading, however, to include only hybrid and electric vehicles in the “green car” category. Petrol- and diesel-fueled vehicles are becoming much more efficient, to the point that the gap between CO2 emissions from ICE vehicles and those from hybrid and plug-in hybrid electric vehicles is forecast to be closing quite quickly. This makes it more complicated to predict future technology trajectories, and has important implications for carmakers' strategies and government policies.

...a high degree of uncertainty surrounds market developments for different products and technologies, particularly with respect to which product or technology will emerge as the most widespread.

—“Market Development for Green Cars”

Beltramello attributes the main barriers to the diffusion of green vehicles to inertia; inadequate infrastructure; government failures; and market failures.

Inertia refers to resistance to change or tendency of economic, human and physical systems to change very slowly. Elements of inertia with respect to the market development of green cars includes low returns on R&D, network effects, barriers to competition and slowly changing norms and habits.

Barriers to entry can arise from increasing returns to scale in networks and contribute to creating a bias in the market towards existing technologies. Consumers may be reluctant to purchase a green vehicle if they are uncertain that a network of refueling/charging infrastructure will be extended far enough to cover their needs. Instead, they will tend to favor the incumbent ICE technologies for which gasoline and diesel refueling stations abound, Beltramello finds.

Path dependence may lead to lock-in failures and dominance of existent designs in systems and technologies. High entry costs may exist for new technologies, and therefore lead to high cost of switching to these new technologies for users.

Many barriers to entry and competition are of a technical nature, Beltramello notes. For example, one factor that is holding back purchases of electric vehicles in particular is the limited driving range. Another technical shortcoming linked to the limited range of EVs is the long time required for charging. Significant technical entry barriers also exist on the supply side, in particular for battery manufacturers.

A high level of uncertainty about the prospects of success of green vehicles and the long timescale for setting up the charging infrastructure may deter firms from investing in the necessary technologies. This market failure is made more acute by timing: the private sector may eventually invest in charging infrastructure, but will probably not do so until sufficient demand generates a revenue stream to earn a reasonable return on investment, Beltramello suggests.

Government’s role should involve not only removing factors of inertia and failures in the market, but also tackling barriers to the development and diffusion of green vehicles created by its own institutional and regulatory systems, Beltramello says. For example, he notes, perverse subsidies and preferences to incumbents (i.e. to conventional fuels and ICE vehicles) represent a key disincentive for manufacturers to develop green vehicles and for consumers to adopt them. Policy unpredictability and regulatory uncertainty can also have a significant impact on manufacturers' decisions as regards the production and commercialization of green cars as well as on adoption by consumers.

A number of market failures also potentially impinge on the diffusion of clean vehicle technologies. Information externalities occur in clean vehicle markets, as consumers do not always act rationally in terms of incorporating fuel savings into their purchasing decisions. In addition, Beltramello says, if negative environmental externalities (i.e. unpriced environmental costs related to GHG emissions and air pollution) are not internalized by firms and households, there will be little demand for AFVs.

To help overcome these barriers and market failures, governments in OECD and non-OECD countries have implemented several types of policy instruments, and thus promote the diffusion and adoption of green vehicles. The policy initiatives reviewed and analysed in this report show that AFVs are being deployed with diverging sets of standards, incentives, business models and degrees of government involvement. In particular, the following elements may explain the sheer variety of initiatives and paths followed in different countries: i) industrial structure and presence of incumbent firms; ii) national policy priorities to improve environmental performance; and iii) distance from the technological frontier and size of the market.

One overarching observation emerging from policy development in OECD and also non-OECD countries is that many initiatives to promote the adoption of green vehicles are taking place at the level of cities, as part of strategies to improve air quality and reduce congestion and noise.

—“Market Development for Green Cars”

Beltramello describes a set of demand policies that play an important role in fostering the development of altern ative fuels and propulsion technologies. These include:

  • Public procurement. Public procurement can tackle many of the factors of inertia that impinge on the diffusion of green vehicles. By creating a signaling effect as lead users, governments can create and/or expand the network that is needed for early adopters and then encourage private firms and consumers to take up green vehicles, Beltramello says.

    Public procurement can also contribute to breaking some of the psychological biases against green vehicles and can help to overcome information asymmetries. However, a failed demonstration program could also result in a backlash against green vehicles, he suggests.

    The risks inherent in using public procurement as a demonstration tool call for thorough evaluations of the impacts of these programmes on consumer confidence vis-à-vis green vehicles and the resulting uptake. However, currently such evaluations are largely absent across OECD countries.

    —“Market Development for Green Cars”

    Challenges to public procurement policies include the lack of capacity to design and implement purchasing programmes that are oriented to stimulating eco-innovations in the transportation sector as well as risking the creation of inefficient policies and of introducing distortions to the competitive process, including in the international context.

  • Performance-based regulations and standards can be designed to foster improvements in the environmental performance of motor vehicles.

    Governments can design fuel economy regulations so that they are technology neutral, and that they foster continuous innovation by allowing flexibility in achieving the outcomes rather than supporting specific solutions. However, when a technology is already locked in, performance regulations and standards may not be sufficient to bring about more radical innovations. In some cases, this has led regulators to turn performance regulations and standards into de facto technology mandates.

    —“Market Development for Green Cars”

    By highlighting the improved fuel economy and environmental performance of a greener vehicle relative to less efficient and more polluting options, performance-based regulations and standards can also help to change consumers’ norms and habits, Beltramello suggests.

    Such regulations also enhance regulatory certainty for carmakers and investors, especially if governments commit for a long-term horizon.

    Beltramello found that performance-based approaches across OECD and non-OECD countries employ very wide and diverse combinations of mechanisms. These illustrate the importance of designing performance regulations so that they induce continuous efforts and behavioral change amongst carmakers and drivers, without locking them in any particular technological pathway.

  • Technology-based standards and regulations affect innovation by setting technical specifications for ensuring interoperability, securing minimum safety and quality, achieving variety reduction and providing common information and measurement. These can contribute to redress some of the failures that are retarding adoption of green vehicles.

    Technology-based standards and regulations can enable the emergence of positive network externalities by ensuring interoperability; by providing manufacturers and investors with certainty and predictability as to the government commitment to sustainable road transport; and contribute further to changing the bias of consumers against green vehicles, and overcome information asymmetries.

    Based on his analysis of initiatives in the area of standardisation, Beltramello found two important challenges for policy makers: getting the right timing for standardization and the international dimension of standardization.

  • Price-based measures can play a fundamental role in addressing the high cost of green vehicles relative to conventional ICE vehicles. These measures can address this barrier by (i) raising the price of the most polluting and energy-inefficient vehicles, e.g. through taxation, or (ii) by lowering the price of cleaner fuels and propulsion technologies, e.g. through tax credits and direct subsidies. These measures can either be technology neutral, or favor specific fuels or technologies.

    Price-based measures may also contribute to changing norms and habits of consumers and overcoming information asymmetries, as they can help to put consumers in a better position to make a rational decision. Finally, taxation of relatively more polluting fuels and propulsion technologies can also correct the unpriced negative environmental externalities caused by road transport.

    —“Market Development for Green Cars”

    These measures fall into two main categories: (i) fiscal and financial incentives (e.g. direct subsidies through financial transfers to buyers or users of green vehicles, or tax incentives); and (ii) fiscal and financial disincentives (taxes and charges that aim at changing the relative prices of inputs and the price of outputs).

    Although several studies found that fiscal and financial incentives have a positive effect on the adoption of green vehicles, the results overall are mixed—especially the cost-effectiveness and budgetary sustainability of the schemes.

    Timing and sequencing is also crucial. Policy makers should send clear signals about the duration of price incentives, while avoiding exposure to large potential subsidy costs, Beltramello said.

    Challenges for developing price-based instruments include the complexity of the task, which also requires highly technical knowledge about particular technologies; increasing awareness of the long-term benefits of green vehicles among consumers; focusing innovations along relatively narrow lines; “picking the wrong winners and losers” by providing direct or indirect incentives and/or disincentives in sectors or technologies on which policy makers do not have full information; and the danger that providing early financial or fiscal support to a technology might prove highly costly if the technology in question is not yet mature enough.

    The issue of equity is also important. Tax credits and subsidies may end up being highly regressive, and only reward those who need them the least. In addition, fuel and vehicle taxes may create a disproportionately big burden on poor households, although the evidence does not seem to support this argument. Price-based measures can play a role in the overall policy mix, but have some limitations in the current context of growing fiscal constraints across OECD countries.

    —“Market Development for Green Cars”

  • Governmental support for commercialization can help overcome barriers to innovation, such as high entry costs and lock-in failures. In addition, newcomers and new business models play a crucial role in the development of green vehicles and their diffusion in the market. Governments may also thus consider introducing initiatives to encourage venture capital investment in the creation and growth of new firms.

  • Government support for the provision of infrastructure can address the important network externalities that prevent the creation of markets for green cars, as well as provide private operators with an incentive to invest. The timing and sequencing of infrastructure deployment is crucial, Beltramello points out; for example, sufficient recharging infrastructure should be in place not only for the initial wave of vehicles, but also for the second phase of the market ramp-up. In addition, it may be appropriate to support the installation of refueling/charging infrastructure in advance of AFV deployment, in order to avoid a potential “chicken-and-egg” problem.

  • Information-based measures can enable individuals to make more informed choices, such as labeling and consumer education and awareness-raising.

  • Networks and partnerships can facilitate co-operation and optimise the use of resources (e.g. knowledge, finance) among a variety of actors. Their outputs range from producing strategic visions for the decarbonization of transport to solving operational and technical issues in putting in place the right framework conditions and infrastructure required for AFVs deployment. Formal evaluations of the impact of networks and partnerships on the market development of green vehicles are generally lacking. However, anecdotal evidence emerging from the experience in OECD countries seems to suggest that they have often provided key governance structures for co-ordinating diverse actors in a complex environment, according to Beltramello.

Beltramello also made a number of suggestions on the design and evaluation of governmental policies:

  • Governments should assess the appropriateness of intervention on a case-by-case basis. Especially in times of tight public budgets, limited resources may restrict the government’s ability to deal with policy concerns on its own; policy makers should consider carefully whether to address the market failure directly or to develop the right framework conditions and a sound business environment, which could enable private operators to overcome the barriers instead.

  • Governments should assess carefully the best incentives to promote green transportation on the basis of country-specific regulatory frameworks, experiences and policy goals.

  • Policy makers should consider the stringency, predictability and flexibility of the instruments’ design to encourage the development and diffusion of green cars.

  • Stable, consistent and long-term policy signals are important for manufacturers and consumers of green vehicles. Policy makers should set and announce clear long-term objectives and targets and communicate under which conditions these might need to be subject to revision.

  • The timing and sequencing of policy implementation is important.

  • Policy makers should ensure technological neutrality, and should ideally support the broadest portfolio of alternatives. Targeted interventions should be carefully designed.

    Targeted interventions can end up favoring specific technological solutions and create or enhance lock-in, although it is very difficult for policy makers to know in advance which option will be the most efficient and effective. But implementing technology-neutral instruments is not always possible. Public resources are finite, and cannot be spent on all innovations. Policy makers should remain alert to the risk that direct support to AFV technologies becomes captured by vested interests and gives rise to opportunities for rent seeking. Incentives should be limited in time and volume, for example by including a sunset clause.

    —“Market Development for Green Cars”

  • “Picking” AFV technologies, for example through technology mandates or targeted incentives, is risky.

  • Ongoing monitoring and evaluation of technologies as well as of technical and commercial challenges can enable flexible and continuous adaptation of policy to current conditions. Communicating clearly and up-front the reasons for possible future changes to policy instruments can contribute to policy predictability.

  • Cost-benefit analyses are necessary to establish the most efficient policy mix and should incorporate environmental, social and economic benefits. The side effects of policies in support of green vehicles should also be carefully assessed.

  • Resources

    • Beltramello, A. (2012), “Market Development for Green Cars”, OECD Green Growth Papers, No. 2012-03, OECD Publishing, Paris. doi: 10.1787/5k95xtcmxltc-en

September 24, 2012 in Policy | Permalink | Comments (0) | TrackBack (0)

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