Maximilian Auffhammer at the uninspiringly named Energy Institute at Haas blog:
Last week one of the biggest environmental scandals since the Deepwater Horizon disaster made its way to somewhere near the bottom of page 11 of most major newspapers. VW admitted to systematically cheating on emissions tests of its Diesel vehicles. This might sound snoozy, until you read up on the details. ...
In a Lance Armstrongian feat of deception, VW has now admitted to having installed a piece of software called a “defeat device” that turns on the full suite of pollution control gadgets when cars are being smog tested. As soon as you leave the testing station and head out for your Yosemite adventure with Fluffy barking in the back, your car emits 10-40 times (!!!!!!!!!!!) the amount of NOx you just reported on your smog check card. ... The EPA will almost certainly sue VW. The penalties involved here are significant. The EPA can ask for $37,500 per incident, which amounts to roughly $18 billion in fines. Plus there will likely be criminal charges filed against VW executives. ...
In my eyes there are two interesting economic points to be made here. The first, maybe more headline worthy, is trying to determine the optimal fine in order to deter other manufacturers from engaging in such behavior. An economist would argue that what we have here is the classic case of an externality. By selling the dirtier vehicles, VW exposed kids, adults and dogs to massive quantities of local air pollutants. VW is responsible and should be liable for this. Hence VW should correct this market failure by paying the full external costs it caused. This calculation would involve estimating the economic damages from this additional air pollution and passing the bill on to VW. My back of the envelope calculation suggests that for the NOx portion this is about $232 per vehicle over three years (far from $37,500).
But, there is a large law and economics literature on determining the fines to achieve the optimal and efficient amount of deterrence. The problem with just passing on the external damages is that VW was not going to be caught with certainty. If the executives thought there was a 1% chance of getting caught, it might have been more worthwhile to cheat than if they thought that they were going to get caught with certainty. In this case, the penalty should be approximated by the external costs divided by the probability of getting caught. This, of course, would be significantly larger than the external costs alone. ...
Yikes. Here is the press release from the EPA.
