Wissam El Hachem

4 min.

5 May 2022

Interactions between Manufacturers R&D Investment and Government Regulations: The case of transition to alternative fuel vehicles

Car manufacturers, faced with an increase in consumer environmental awareness (CEA), have realized that product greening is a sound value proposition that promotes consumer goodwill and brand value. Therefore, they spend significant proportions of their revenues on research and development (R&D), like Volkswagen that spends more than 5% of its revenue on R&D, with a large proportion dedicated to reducing emissions and developing alternative fuel vehicles (AFVs).

Meanwhile, to address environmental concerns, governments use various mechanisms to encourage firms and consumers to decrease their carbon footprints—including carbon taxes, emissions, and AFV sales thresholds—and consumer subsidies. Stricter environmental regulations are obviously expected to encourage better environmental performance; however, complex trade-offs occur between firms’ profitability and environmental targets. This is challenging for both governments and manufacturers who must accordingly adapt their policies to minimize unintended consequences.

Just Transitions

There is a widely held conviction that unjust transitions are unsustainable, as proved by the slow AFV transition behavior historically exhibited across nations. This behavior can be partially explained by the fact that a just transition must explicitly consider differing points of view, including the social dimension of the triple bottom line (i.e. Economy, Environment, Social), resulting in a plethora of paradoxes and trade-offs, e.g., fuel consumption taxes affect more residents of poorer regions, who have longer average commutes; and banning old, “dirty” vehicles limits the travel choices of low-income groups that rely on these vehicles. Neglecting such trade-offs lowers the willingness of firms and consumers to adhere to ambitious environmental targets, and sometimes causes backlash, as evidenced by the 2018 yellow vest movement in France. Echoing the degrowth literature, the pursuit of environmental justice can potentially jeopardize the economic and social well-being of low-income social groups.

Complexity of AFV Transitions

Transitions from internal combustion engine vehicles (ICEVs) to AFVs are complex and dynamic processes characterized by trade-offs, feedback, and long delays, therefore it is essential to analyze their triple bottom line, acknowledging that trade-offs and paradoxes are inherent in such a context.

Therefore, it is essential to study the interactions between government regulations and the R&D investment of multiproduct car manufacturers in a green-sensitive and heterogeneous market.

Interactions between the different stakeholders

Government regulations and manufacturers’ R&D investment at any given point of time, depend on the AFV market share and the willingness of consumers to consider and pay for greener products. Since these conditions evolve over time, the interactions between regulations and manufacturers’ investment must be dynamic and responsive.

Relying on a system dynamics simulation study, we offer insights to help manufacturers improve their strategic R&D decisions in line with regulatory frameworks while ensuring just and sustainable transition to AFVs. We also advise policy makers on how to use regulatory instruments, mainly ICE taxes, AFV Subsidies, and AFV quotas, depending on their pursued objective. We also consider the consumers: They choose between several types of vehicles taking into consideration several factors such as purchasing price, operating costs, maintenance costs and availability of infrastructure. Their choices influence back government regulations and manufacturers R&D investments.

Moderation rather than Aggressiveness

Moderate levels of government intervention and manufacturers’ investment worked best, with both mild and aggressive policies compromising the sustainability of the transition.

When the government pursues an aggressive (vs a moderate) agenda by adopting overly ambitious AFV sales targets, and/or strict emissions regulations and ICE taxes, and/or quite generous AFV subsidies, it actually slows down the AFV transition (i.e. less people overall adopt AFVs) and increases the overall emissions. This output is mainly due to the inability of manufacturers to keep up with these regulations, resulting in expensive R&D investments diluted on too many fronts, yielding little benefit, thus not incentivizing consumers to make the transition.

When manufacturers invest in R&D to keep up with government regulations and with CEA, they ought to do so with the utmost care to how the resulting benefits/penalties are split between the different vehicle alternatives. Meaning, if the AFVs performance increases significantly, while that of the ICEVs increases only slightly, consumers will perceive this as unjust. More so, if manufacturers are not able to adhere to regulations, the ensuing penalties ought to be redistributed and reflected fairly in terms of R&D investments and purchasing prices of different vehicle alternatives, rather than having ICEV consumers take the full blow.

Long-term vs Short-term

Manufacturers should expect lower short-term profits due to the additional R&D investments needed to keep up with CEA and government regulations, while also facing growing dissatisfaction among certain consumer segments with either ambitious environmental aspirations and/or diminishing purchasing power. However, profits do recover and increase in the mid to long term by preserving consumer goodwill, thus ensuring the manufacturers survival in the marketplace.

Sustainable and Just Transitions

As briefly explored above, AFV transitions are complex. By keeping sustainability as the main objective of such transitions, with distributive justice as a potential indicator of the social dimension, all stakeholders are better off. This is highlighted in better vehicles quality and lower prices on the long run, as compared to when a myopic approach is adopted.

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