Why Policies to Cut Energy Use Are Badly Designed: Brian Barry

Feb. 9 (Bloomberg) -- Most policy ideas for reducing demand for energy rely on one of two claims about why consumers need to be steered toward using less of it. Call these claims Flawed People and Flawed Markets.

Flawed People consume too much energy if they do a poor job of considering energy prices in their decisions, and thus make bad choices about which cars and other energy-intensive products will suit their tastes in the most cost-effective way. Flawed Markets lead to too much energy use if people do a great job of considering energy prices in their decisions, but those market prices are too low to reflect the real costs to society. In this case, people who make cost-effective choices for themselves create negative spillovers for everyone else.

U.S. energy policy overstates the harm caused by Flawed People, and does a poor job of identifying them and promoting better outcomes. So this approach is largely ineffective. That is the lesson of an excellent new paper, by Hunt Allcott of New York University and Michael Greenstone of the Massachusetts Institute of Technology, which asks whether there is a large “energy efficiency gap” in the U.S. That is, do many American consumers and businesses cost themselves a lot of money by using energy less efficiently than they would if they made smarter decisions about cars, appliances, building insulation and so on?

Efficiency Gap

Many people believe -- and many policies are implicitly based on the idea -- that there is such a gap, and that it is huge. Drivers may not take full account, for example, of the true costs to themselves of owning cars that guzzle more gas. If this is a big problem, then policies that subsidize purchases of fuel-efficient vehicles -- or that try to skew the relative cost and range of choices that carmakers offer in ways that boost efficiency -- may save energy and money at the same time.

Similar issues might arise in homes if people don’t understand, or properly weigh, the advantages of more energy-efficient appliances, or heating and air-conditioning units.

It is a good idea to be skeptical about such free lunches, yet many American policy makers seem especially confident that they are out there to be had so long as the food is transported in a hybrid vehicle, cooked in an energy-saving oven and served in a well-insulated restaurant. The U.S. thus employs a wide range of costly policies to subsidize energy-efficient choices. The tendency to exaggerate the ease of cutting energy use has been exacerbated by studies that purport to show huge potential savings.

A widely cited 2009 report by McKinsey & Co. claimed, for example, that the U.S. could reduce energy use by 23 percent, and save hundreds of billions of dollars, just by using more efficient appliances and equipment in homes and factories, and by better sealing the nation’s buildings. And that didn’t count any potential savings from more fuel-efficient cars and trucks.

Allcott and Greenstone offer two good arguments to support the view that most policies aimed at closing this perceived energy-efficiency gap have been misguided and unhelpful.

First, they round up examples to show that many U.S policies that try to close the gap don’t really save much. This is largely because the efficiency shortfall isn’t even close to being as wide, or as widespread, as many advocates of these policies have argued.

Consider the subsidies that many electric utilities offer consumers who buy energy-efficient appliances, heaters and air conditioners. The most credible estimates, Allcott and Greenstone point out, show that from 1992 to 2006 these “demand-side management” programs lowered demand by maybe 1 percent to 2 percent, and that the energy conserved came at a cost of between 8.5 cents and 10.4 cents per kilowatt-hour saved. Since national prices averaged 9.1 cents per kilowatt-hour, this doesn’t look like a great bargain. Another potential source of inefficiency -- landlords who don’t do enough to shave energy costs for their tenants -- also looks small, increasing residential energy use by perhaps 1 percent.

Car Purchases

Or take cars. They cite a pair of clever studies (one conducted by Allcott with a co-author) comparing the way new-and used-car values respond to changing gasoline prices. If gas prices rise, for example, the price of fuel-efficient three-year-old cars should increase relative to prices of three-year-old gas-guzzlers.

This may not happen as much as it should, in which case probably consumers aren’t devoting enough consideration to their likely fuel costs when deciding how much to pay for their cars. In any case, the cost of this oversight, if it exists, is small. One study suggests that consumers aren’t leaving any potential energy savings on the table; the other suggests that there may be enough inefficiency to cost consumers between $1 and $20 per car buyer each year.

In short, many consumers may be confused about the relative energy costs of different cars, appliances and home-energy options. But the potential savings from steering them in greener directions using current policies seem puny. Those who enact these policies, or predict their benefits, often ignore the hidden costs of using or switching to energy-efficient models.

Policy makers also tend to prefer broad subsidies that fail to account for the huge variation among consumers, only a small segment of whom might be induced to change their behavior in a cost-effective way.

Are there better policies to choose from? Here, Allcott and Greenstone make another contribution by setting out the distinction between inefficiencies and negative spillovers in energy use. Narrowly targeted and better-designed policies could conceivably achieve modest efficiency gains, but that would require much clearer thinking about whom to reach and how.

Tax Policy

More importantly, the best way to solve the spillover problem is to tax the externality -- in other words, raise the private cost of using energy to reflect its real social cost. Increasing the price of gasoline, for example, would influence not only which cars people buy, but also whether they then choose to consume less fuel after they have made their purchase.

Even if there is an argument for influencing consumers’ choice of car through additional policies on top of a tax, the costs of Corporate Average Fuel Economy, or CAFE, standards cannot be justified even remotely on these grounds.

(The two researchers are hardly alone among economists in preferring a tax to CAFE standards. A diverse panel -- put together by an initiative that I direct at Chicago’s Booth School -- of Greenstone and 40 other economists from seven universities recently considered this issue. They agreed overwhelmingly that a tax on the carbon content of fuels would be a less costly approach.)

Whether better policies are adopted, however, may hinge on an analogous problem in politics. Has the U.S. pursued ineffective approaches to energy conservation because its policy makers are flawed people, in which case maybe they can be nudged to consider better ideas and information? Or do their energy policies show that politics is a flawed market, which inflicts too little pain on officials when their choices impose negative spillovers on the public?

(Brian Barry is a professor of economics and executive director of the Initiative on Global Markets at the University of Chicago Booth School of Business, and a contributor to Business Class. The opinions expressed are his own.)

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