Conserving energy: Paradox and policy

Tilak K. Doshi, The Straits Times 15 Mar 10;

SINCE the Copenhagen climate change meeting in December, much ink has flowed on the subject of energy efficiency and what governments can do about it.

Much of the literature has focused on 'emission abatement curves'. These curves trace the outlook for new energy-saving or carbon-capture technologies that become competitive as the cost of carbon emissions increases.

For example, when petrol or diesel prices are high enough to reflect the carbon content of such fuels, hybrid petrol-electric cars become more attractive to consumers. Likewise, at even higher fuel prices, fully electric vehicles may begin to compete with hybrids, and so on. Abatement cost curves provide a map of possible technology futures in an increasingly carbon-constrained world.

Yet the most remarkable aspect of these curves is not what they tell us about emerging technologies but about those that are already cost-competitive. Studies show that people are slow to adopt cost-effective energy-conserving technologies. Examples include compact fluorescent light bulbs, improved insulation materials and energy-efficient household appliances. This then is the paradox: Why does there seem to be so little investment in these forms of technology when they save money and energy?

To this seeming paradox, economists have generally responded in one of two ways: Either it is a market failure of some sort or consumers' behaviour does make sense despite apparently objective cost-benefit calculations to the contrary.

One obvious source of market failure is the lack of information about the available technologies. If companies fail to publicise them on a large enough scale, as is likely, there is a case to be made for the authorities to provide the information free or at subsidised rates.

But what if the slow spread of cost-effective technologies is due not to consumer ignorance but rather to rational behaviour? In this case, there would be no basis for government intervention.

Consumers and businesses may come to the conclusion that there is little point in investing in new technologies at the moment, especially when the costs of adoption are likely to fall as the technologies become more commonplace in the future. It may pay to just 'wait and see'. So what may seem at first like a market failure, may in fact be the result of rational choice.

Another example of market failure arises when the party which invests in energy-saving technology hardly benefits from it. If the owner of a house cannot ask for a higher selling price for his property even if he makes it more environmentally friendly, he will have no incentive to invest in energy-efficient appliances. Similarly, landlords who rent out their homes have no interest in energy efficiency since they do not pay the bills and enjoy the cost savings.

In this case, it may make sense to develop an audited home energy rating system to give house buyers and renters reliable information about their likely savings on energy bills. This would make energy-efficient properties more attractive and encourage landlords and homeowners to invest in green technology.

In making energy technology choices, some situations suggest a role for government intervention while others do not. Depending on the specific nature of market failure or apparently poor consumer choices, correct responses may range from better education and regulations - mandatory product labelling, energy-efficiency audits of new buildings, etc - to using market-based incentives such as carbon taxes and 'cap-and-trade' regimes. In some cases, the correct policy may well be to do nothing.

Those who would argue for aggressive taxpayer-financed investments in green technology should beware of premature and costly transitions to low carbon-emission technologies. The tendency for government funding initiatives to be captured by special interests has been widely observed. The promotion of ethanol in the United States, for example, has probably more to do with the clout of powerful senators from corn-growing states than with the national interest.

Despite the apparent paradox of energy conservation, consumers and entrepreneurs betting their own money on new energy-efficient technologies are the ones making intelligent choices.

The writer is the chief economist at the Energy Studies Institute, National University of Singapore.