Electric Vehicle Subsidies: Holy Grail or Pandora’s Box?
June 30, 2021
Ashmit Vyas is a rising senior in the School of Arts & Sciences majoring in Economics and in the Benjamin Franklin Scholars Program. Ashmit is interested in learning about ways in which government can work with firms to develop sustainable growth strategies; how world leaders can be incentivized to balance competing financial and environmental interests; and how stakeholders from the private sector influence attempt to curb climate change. He participated in the Risk Center’s Undergraduate Fellowship for the 2020-21 academic year.
Author’s note: At time of writing, electric vehicle subsidies were a significant component of the White House’s infrastructure proposal. However, these subsidies were not included in the revised bipartisan plan that was formally unveiled on June 24, 2021.
At first glance, President Biden’s proposed $174 billion electric vehicle (EV) package makes a lot of sense. The transportation sector clearly has a pollution problem and accounts for 29% of total greenhouse gas emissions in the United States. Despite being touted as the long-term, eco-friendly replacement for internal combustion engine (ICE) vehicles, EVs made up just 2% of nationwide auto sales in 2020.
Biden’s new proposal, which comes as part of a multi-trillion dollar infrastructure plan, will subsidize electric vehicle sales and fund the installation of charging stations across the country. This is a statement of intent from a President who promised to place climate policy at the forefront of his political agenda. In reality, however, such a radical intervention in the EV space would be needless at best and counterproductive at worst.
First and foremost, the subsidies represent a colossal waste of taxpayer dollars because the electric vehicle space does not need to be rescued. Despite the fact that EVs are relatively uncommon on American roads, all the evidence suggests that the market is approaching a tipping point. Manufacturers are already investing heavily in R&D, with GM set to commit $27 billion to EV research and production over the next five years. More importantly, new entrants are emerging every day.
Signs are similarly promising on the demand side. Despite the current adoption rate of 2%, the US still ranks 2nd in the world for EV sales. Meanwhile, the number of Americans who said they would consider buying an electric car rose by 50% over the course of 2020. These changing sentiments have coincided with a steep drop in the cost of lithium-ion batteries. Priced at over $1000 per kilowatt-hour some eleven years ago, they are expected to break the $100/kWh barrier by 2023 according to researchers at Bloomberg New Energy Finance.
The significance of this milestone cannot be overstated because battery costs are one of the most important determinants of EV prices. Price parity between electric and ICE vehicles is now surely on the horizon, barring any shocks to the markets for oil or raw cathode materials.
Meanwhile, a shortage of charging stations will soon be a thing of the past. The likes of Walmart and Target have started to install charging ports in their parking lots, joining mainstream providers such as EVgo, Electrify America, and Chargepoint. It’s a nifty cycle; as access to charging stations improves, more customers buy EVs. And as more customers buy EVs, there is greater incentive for businesses to supply charging services. According to the Department of Energy, electric charging stations already comprise 23% of total vehicle refuelling stations across the US.
Secondly, and perhaps more worryingly, government intervention could do some serious damage to burgeoning markets in EV infrastructure. Given that businesses are already going all-in on resources like charging stations, the proposed subsidies will likely induce a crowding out effect that stymies private investment in such areas. Crowding out occurs when unnecessary government involvement discourages private enterprise, either by filling a need that would otherwise be filled by businesses or by triggering an increase in interest rates.
Subsidies also distort the competitive landscape. Let’s be clear: governments are grossly ill-equipped to pick winners and losers in any industry. Aside from lacking any unique insight into markets, government officials also bear no stakes in a company’s success or failure. The arbitrary allocation of subsidies keeps failing companies afloat while inflicting a competitive disadvantage on promising but relatively unknown players.
And that’s just the tip of the iceberg. The problem of resource misallocation is exacerbated when fiscal support programs succumb to cronyism. We’ve already seen evidence of this in the energy sector; for instance, both the New York Times and the Washington Post reported that some of the biggest beneficiaries of the failed 1705 loan program had connections to White House officials. Even if you doubt those claims, it’s hard to argue that subsidies don’t cause glaring market inefficiencies. It is competition, not government interference, that breeds innovation.
Veronique de Rugy of the Mercatus Center at George Mason University suggests that a signaling effect may also be at play. That is to say, companies who fail to attract government subsidies may appear less appealing to private investors than those who do receive backing. This further erodes competition by doubling down on the challenges already faced by young entrepreneurs and new companies.
At the end of the day, the President should be commended for taking the climate crisis seriously. However, there is a difference between urgency and desperation, and the proposed $174 billion EV package undoubtedly falls into the latter category. Policymakers and politicians should know better than to abandon the basic principles of economics in favour of alarmist intervention, especially given that the trajectory of the EV market looks so promising. A more prudent goal in the fight against climate change would be the pursuit of a global carbon tax, similar to that proposed by Nobel Laureate William Nordhaus.
History has taught us numerous times that government intervention does not work better or faster than a functional market. On the contrary, it should be reserved as a corrective tool against market failures. Meddling in the EV space would not only represent a waste of resources but also pose grave risks to an industry that is currently soaring.
The views expressed in this blog post are that of the author and do not reflect an official position of the Wharton Risk Center.