I had dinner recently with a friend who is a money manager. He told me that he planned to buy stock in a major automobile company. He said that the stock had earnings of $2.00 per share. But that was because the company was making $3.00 per share on its sale of gasoline-powered cars and losing $1.00 per share on its sales of electric vehicles. With the incoming Trump administration set to loosen or eliminate the Corporate Average Fuel Economy (CAFE) standards, he figured that the company would soon be out of the EV manufacturing business and back to the $3.00 per share stock he thought it should be.
My friend may get his wish. Current CAFE standards require U.S. automakers to achieve an average fuel economy standard across their respective fleets of more than 50 miles per gallon by 2031. This requirement has been a major force in driving automobile company investment into electric vehicles. The CAFE standards essentially force automakers to invest in and produce electric vehicles in order to comply with the ever-tightening standard. During his campaign, President-Elect Trump referred to this as the “electric vehicle mandate” and vowed to end it.
The President-Elect’s desire to loosen or end the fuel economy standards is likely driven by his perception that fuel economy standards are intended to fight the problem of climate change, a marque issue of his political opponents. His assumption is correct, but only in part. The real problem the fuel economy standards address is not climate change–it is my friend the money manager.
Auto company executives are divided in their support of the fuel economy standards. They recognize that their companies would be more profitable if they were not investing in electric vehicles. But they also recognize that the electrification of most transportation is inevitable. It is where vehicle technology is headed for many reasons. Whether it will take three, five, ten or fifteen years to address the challenges of this new technology and produce profitable mass-market EV’s is as yet unknown. But those executives know where the technology is headed and know that the companies that dominate that technology will be the ones that dominate the automobile industry of the future.
The problem is that my money manager friend does not care. What he cares about, and what his clients care about, is what the price of the automobile company stock is this quarter. Whether earnings this quarter are $2.00 per share or $3.00 per share makes a big difference. This focus on short-term performance is not evil; my friend is a nice guy. It is a quirk–a defect–in the way capital markets are structured in the United States and much of the Western world. Capital markets if left on their own will overemphasize short-term business performance and underemphasize long-term business performance.
The most important purpose of the fuel economy standards is to address this defect in the capital markets. Properly understood, the billions of dollars that automobile companies are currently investing, and losing, in electric vehicles are a research and development expense. The point of the fuel economy standard is to force all companies to fund this R&D in next-generation automobile technology equally rather than engage in a race to the bottom to meet my money manager friend’s siren call for better short-term performance.
Electric vehicles are the future of the automobile industry. The companies that make the necessary, and to be sure expensive, R&D investments in electric vehicle technology today will own that industry tomorrow. My money manager friend will be quite content ten years from now to be investing in dominant Chinese automobile companies. But the 1.1 million Americans who work in the automobile industry today and their children cannot afford to be so dispassionate. If America wants to keep a domestic automobile industry, our companies must make the necessary R&D investments to keep it.
The US fuel economy standard is not an electric vehicle mandate. It is an R&D mandate. If the next administration believes that America will be better off cutting corporate R&D in the automobile industry rather than stimulating it, that administration might make my money manager friend a happy man. But it will ultimately make America and the American economy weaker.