The Volkswagen (VW) emissions scandal has broader implications than the potential damage it can do to Europe's biggest carmaker. It is the result of Europe backing the wrong emissions-reducing technology on a regulatory level. There is now an opportunity to reverse that error and force the continent's car manufacturers to concentrate on hybrid and electric vehicles. They have the technology and resources to reshape the market.
The scandal is about VW's bad business decision to cheat testing equipment so it could rush new engine models to market in the United States. It is also about a failure of regulatory oversight and testing technology.
Most of all, however, it's about diesel engines: They were the ones performing so badly on the tests that VW engineers had to look for a workaround so marketers could trumpet the advent of "clean" diesel. VW had an advantage in diesel technology, which it wanted to leverage in the US, for a reason.
In the mid-1990s, the European Commission and European Union (EU) member countries' governments started a campaign of massive intervention to stimulate the use of diesel engines in cars.
At the beginning of that decade, Europe and Japan had about 10 per cent of diesel automobiles on the road.
After 1995, the trends diverged widely: In a 2013 paper, researchers Michel Cames and Eckard Helmers estimated that without the government intervention, diesel automobiles would have accounted for about 15 per cent of vehicles on the road in 15 core EU countries, but now they make up 35 per cent of total cars.
This is the result of lower excise taxes on diesel than on gasoline throughout most of Europe and relatively lax environmental standards for diesel engines, allowing higher emissions of nitrogen oxide and harmful particles.
Some countries, such as Belgium, France and Spain, have long imposed lower taxes on diesel cars. In France, Peugeot even obtained a government guarantee of such a tax policy before prioritising the development of diesel engines over gasoline ones.
As a result, most core EU countries have more diesel cars on the road than any other kind. Only the Netherlands, and, to a limited extent, Germany, have bucked the trend by avoiding diesel-stimulating policies: It is possible that the incentives were the result of oil industry lobbying - as the sales of fuel oil fell, refiners needed to sell more diesel fuel, which is a similar type of product. But they probably stemmed from a misunderstanding of the environmental consequences.
"Green" regulation in European countries has centred on CO2 emissions, and diesel exhaust contains relatively little of that gas. Smog-creating NOx and soot particles were overlooked until the ultra-strict Euro 6 standard came into effect this month.
The French authorities have now realised this. It would have been hard not to: Paris now has a smog problem, which it did not have in the 1990s.
"In France, the diesel engine has long been privileged," Prime Minister Manuel Valls told an environmental conference in November last year. "That was a mistake."
The government now wants to move towards a diesel ban, which will force Renault and Peugeot to make a difficult transition as about two-thirds of the cars they now sell in Europe are equipped with diesel engines.
In fact, most European carmakers have a bad case of diesel dependence: Modern diesel engines are capable of keeping emissions below levels permissible under Euro 6.
Implementing the necessary technology, however, makes the cars more expensive, may affect their performance and requires the owner to watch the level of yet another liquid - urea, used to reduce NOx.
So even the cars sold today do not meet the emissions standards on the road, regardless of how they do in tests. Following the VW scandal, testing is likely to become more rigorous both in the US and in Europe, and more producers will be caught and fined for non-compliance.
There will be only two paths for them to take: making sure the emissions performance of all new diesel cars is irreproachable - which is not easy in the real world - or shifting production towards hybrid and electric vehicles, as Japanese companies did when they decided diesel was on its way out.
In 2013, according to the International Council of Clean Transportation, Japan had 21 per cent of hybrid and electric vehicles in its fleet - more than any country in the world.
The European leaders in the technology, Norway and the Netherlands, had 12.8 per cent and 11.3 per cent, respectively. Germany had just 1 per cent. European automakers have the technology to compete in the electric vehicle market: Their models outsell Japanese and American ones in EU countries where electric powertrains are popular.
In business terms, however, the move away from diesel - which should accelerate now - will be extremely costly, much more expensive than the regulatory fines the industry will probably face in the aftermath of the VW scandal.
There is light at the end of the tunnel, though.
Once the transition is completed, the Europeans, with their engineering strength, will make the hybrid and electric market much more competitive. In the US, too, Volkswagen will be back: After all, its e-Golf outsells the Tesla Model S in Norway today.
BLOOMBERG
