Four reasons to be wary of energy-efficiency mandates

On April 30, Ted Gayer appeared before the 

Senate Committee on Energy and Natural Resources

 to discuss energy efficiency. This blog post is a summary of his testimony. Ted will also be featured on the Energy Efficiency Markets Podcast to discuss these issues further on May 6. Download the podcast on iTunes or 

www.EnergyEfficiencyMarkets.com

 to listen in on the discussion.

Driving a car, running an air conditioner, or doing laundry are all activities that use energy and therefore result in pollution. If energy consumers are not charged a price that accounts for these pollution costs, they will use more than the socially optimal level of energy. The government could work to correct this behavior through market mechanisms that raise the price of pollution. Unfortunately, the federal government’s regulation has largely taken the form of energy-efficiency mandates, which are a less effective way of reducing pollution. Here are four points that suggest we should take a cautionary approaching to applying overly-prescriptive energy-efficiency mandates:

1. Economists agree that market prices efficiently communicate information about the strength of consumer demand and the scarcity of supply for a good or service and that those prices are misleading to the extent that they don’t account for pollution costs associated with the purchase or operation of goods. In the market for appliances, for example, prices reflect both constraints on production, such as the state of technology, and how much consumers value features such as energy efficiency and convenience. The problem is that consumers are likely to overuse energy because the price on their electricity bill does not account for the environmental damage caused by their energy use.

2. The best way to address environmental damage caused by energy use is for the government to charge a price for these pollution costs. By pricing pollution, consumers and businesses would face the full cost of their energy use, which would then create incentives to reduce pollution as cheaply as possible through some combination of new technologies, alternative fuels, and conservation.

There are a number of reasons why energy-efficiency mandates are more costly than the market-friendly approach of setting a price on pollution. First, a one-size-fits-all energy-efficiency mandate ignores the substantial diversity of preferences, financial resources, and personal situations that consumers and businesses must consider. Consumers and businesses know these circumstances far better than regulators and are therefore much more knowledgeable about the costs and desirability of various strategies to reduce pollution. Thus a signal in the form of higher prices would lead to more cost-effective pollution reduction than a simple regulatory mandate.

Second, an energy-efficiency mandate lowers the energy cost of using the products affected, which provides an incentive to use those products more and offsets some of the energy reduction. Moreover, energy-efficiency mandates apply only to new products, which can create an incentive for consumers and businesses to retain older, less environmentally-friendly products.

3. Recent energy-efficiency mandates were advertised as “greenhouse gas initiatives,” but the environmental benefits were estimated to be small and were frequently outweighed by the costs they impose. For example, for the recent fuel economy mandates for passenger cars, the EPA estimated they would cost $192 billion, while the greenhouse-gas benefits would only be $46 billion – and most of these benefits would go to countries outside of the US. Energy-efficiency mandates for other consumer goods, such as clothes dryers and room air conditioners, were evaluated similarly: by the agencies’ own estimates, the costs of these regulations outweighed the environmental benefits they achieved.

4. In order to justify these mandates, the agencies assert that consumers and businesses are irrational when buying energy-intensive goods and thus receive massive benefits if the government restricts their choices. The agencies invoke broad references to the behavioral economics literature to support their claims of consumer irrationality, but they present little or no concrete evidence. They also ignore the key policy implication of behavioral economics, which is that it is more effective to address poor decision-making through soft regulatory “nudges” such as providing clearer information to consumers, rather than going straight to using costly mandates that restrict choice.

Given the political unpopularity of the more economically sound approach of levying a tax on pollution, we are opting for policies that are advertised as environmental protection but are justified by weak claims of consumer protection. In other words, we are shifting regulatory priorities from the important goal of reducing the harm individuals impose on others (through pollution) towards the nebulous and unsupported goal of reducing harm individuals cause to themselves by purchasing purportedly uneconomic products. This shift results in a host of costly regulations that are less effective than a government policy that simply sets a price on pollution.

It also establishes a dangerous precedent: if agencies can justify regulations on the unsubstantiated premise that consumers and businesses (but not regulators) are irrational, then they can justify the expansive use of regulatory powers to control and constrain virtually all choices consumers and businesses make.

Assuming that citizens are not capable of making sensible decisions that affect their own pocketbooks is not the right way to advance the important goal of enhancing the quality of our environment.