What regulation is about: reducing risk
Trump manages to get all the automakers on the same page
To hear some conservatives talk about it, regulation is just plain bad. It kills jobs. It forces companies to move their operations overseas.
So what a surprise some of them had the other day. In response to a Trump proposal to get rid of Obama-era regulations requiring the automakers to produce more fuel efficient cars, the competing automakers combined to do something unexpected: they asked Trump not to get rid of the regulations.
In what might be seen as somewhat surprising language to some critics of regulation, the automakers argued that Trump’s proposal could result in “untenable” instability and lower profits.
The explanation being offered for this move is the potential development of two automotive markets in the United States: one with higher emissions standards and one with the lower federal standards. You see, a number of large states, including California, have implemented their own emission standards, something they are empowered to do. With those states making up such a substantial portion of the U.S. auto market, still the second largest in the world, the automakers would, according to them, be required to produce two versions of each vehicle, one for each part of the country.
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That explanation seems to ring hollow, however. There is an easy solution for the automakers: simply produce one version of the vehicle that meets the higher standards. Emission standards are a floor, not a ceiling. As a result, if the automakers comply with the standards in the more demanding states, they will also comply with the standards in the states deferring to the Federal government on the question.
Indeed, such bifurcation of issues between the Federal minimum standard and higher state requirements are quite common. The best example is the minimum wage. In Michigan, we have a minimum wage of $9.45 per hour. In Indiana, it is $7.25, while in Ohio, it is $8.55. What’s the deal with such diversity here in the Great Lakes region? Such a range of minimum wages, however is common. A state can adopt any minimum wage it wants, as long as it is at least what the Federal government requires: $7.25 per hour.
There are other fields where you see a similar bifurcation of law, with a federal minimum with certain states going above and beyond what the federal law requires, including Bankruptcy, civil rights, occupational safety and health, and workers’ compensation, to name a few.
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So if such an arrangement is common, and the automakers have an easy solution to the problem, why are they so opposed to Trump’s attack on the regulations?
This comes down to something I always explain to my students as follows. What is it that business fears most? Students will reply lawsuits, high costs, taxes, etc… But in reality, what business leaders fear most is risk. That’s why, for example, most businesses incorporate in Delaware. Not because it costs less, but because with most large corporations organized there, the courts are well acquainted with corporate law and rule with some consistency.
Other issues can be budgeted for. You have insurance to cover potential losses, and you hedge against price increases. By taking these steps, you can create some consistency in your costs, and you simply pass these costs on to your customers, with confidence that your competitors have similar costs. What creates a real crisis for a business, however, is when they have set their prices based upon certain expected costs, and something unexpected arises blowing their budget completely out of whack. That’s why businesses fear risk.
One way to reduce risk is through regulation. Regulation creates a floor that everyone must comply with. If you are a carmaker concerned about safety, and so you build cars to be safer than the regulations require, your cars will cost more than those of your competitors. In some cases, that might be a selling point — consider Volvo. But among large swaths of customers, that will put you at a competitive advantage.
On the other hand, if government regulation requires a certain level of vehicle safety that you believe is appropriate, you can be confident that your competitors will not be able to underprice your product because they have to meet the same standards you do.
In that way, regulation actually reduces risk. You know the costs that everyone must meet, and you need not fear that a competitor will undercut you.
The automakers are not stupid. They realize that in the long-term, electric vehicles and other highly fuel efficient vehicles will become the norm.
As a result, they have been investing heavily in such vehicles. Indeed, it appears that the reason for Fiat-Chrysler’s courtship of Renault was to access Renault’s advanced research on electric vehicles. Same for Ford’s $500 million investment in Rivian.
Such investment doesn’t come cheap. Inevitably, the cost of this research will be built into the price of the vehicle you buy. There are some automakers not making such investments. Most of them don’t do business in the United States or Europe due to the high cost of complying with our safety and environmental regulations. But they are major players in China, India, South America, and other developing countries. Their cars are cheap, but the trade-offs in terms of safety and pollution are unacceptable to most Americans.
The problem is that if the regulations that may increase the cost of American cars but also guarantee us safe and environmentally friendly vehicles go away, then one of these bottom-feeding automakers may decide to enter the market. Suddenly, there will be a competitor undercutting the established automakers on price and requiring them to cut costs, likely reducing their investment in future vehicle technology.
The fuel economy standards established by the Obama administration and California require automakers participating in the American market to develop future-oriented efficiency technology. Eliminating this requirement will create a long-term problem for the automakers: should they cut bait on the investment they have already made on fuel efficient technology, or should they risk being priced out of the market. The way to avoid this risk is to have the regulations stay in place.
Auto executives don’t have crystal balls. They can’t know if low cost new competitors will enter the market if regulations are reduced. But they can be assured that a lower cost new competitor will NOT enter the market if regulations are NOT reduced. Such certainty is something automakers are willing to pay for.
The story conservatives tell about regulation is appealing because it is simple: regulation is bad. The problem is that it is too simple. The automakers are trying to bring that fact to the attention of our President right now.
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