Environmental Policy as a De Facto Industrial Policy: Evidence from the Japanese Car Market

This study examines the Japanese car market to assess whether a subsidy measure for fuel-efficient and low emission cars that were introduced in 2009 was designed to achieve an environmental goal effectively or was distorted to subsidize domestic firms. I estimate a structural model of oligopolistic competition in the presence of the subsidy measure; and using the estimates, I conduct counterfactual experiments to analyze the cost-effectiveness of the subsidy design from an environmental perspective. A key feature of the subsidy measure is that it included a Japan version of the “cash-for-clunkers” program that could be applied if a car aged 13 years or older was scrapped. To account for the scrap incentives, I incorporate an empirical car age distribution when estimating the demand side of the model. The findings of this paper are as follows: first, the actual fuel economy criteria that were used to qualify for the subsidy were too lax to achieve the environmental goal. Second, these lax criteria allowed Japanese firms to earn more than under the cost-effective criteria, which thereby implies the distortion of the subsidy design from an industrial policy perspective. Third, the policy was not necessarily harmful for foreign cars, as the lax criteria allowed some foreign car models to be eligible for the subsidy and increased the subsidy payment to foreign cars.