Subsidizing Fuel Efficient Cars: Evidence from China's Automobile Industry

The Chinese automobile market is the largest in the world with annual sales exceeding 20 million vehicles. The tremendous growth in sales---over 200 percent from 2008 to 2015---and concerns over local air quality have prompted China's policy makers to incentivize the adoption of more fuel efficient vehicles. We examine the response of vehicle purchase behavior to China's largest national subsidy program for fuel efficient vehicles during 2010 and 2011. Using variation from the program's eligibility cutoffs, we find that the program boosted sales for subsidized vehicle models, but that the program also created a substitution effect within highly fuel efficient vehicles and most subsidies went to inframarginal consumers. This substitution effect greatly reduces the cost effectiveness of the program. We calculate that the average cost per ton of carbon dioxide saved is over 82 USD, well above the social cost of carbon used in U.S. regulatory filings. Using the framework in Boomhower and Davis (2014) and accounting for local pollution benefits, we show that ignoring the substitution effect would lead one to conclude that the program is welfare enhancing, whereas in fact the marginal cost of the program exceeds the marginal benefit by almost as much as 300 percent. We also show that the program was not well-targeted; the effect of the subsidy on sales of fuel efficient vehicles was smaller in areas where consumers were more likely to purchase fuel inefficient models or were lower educated.