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Economic Efficiency, Not ‘Energy Efficiency’ (Economist Cordato parses a sacred cow)

Energy efficiency and energy savings are considered to be intrinsically good. Politicians of all stripes sing the praises of less-is-more. Only one problem: this view is simplistic and wrong from the economic point of view.

Energy efficiency is so central to the current energy conversation that to criticize it is to take on the unenviable role of the contrarian or, as some have called me, the curmudgeon. In a recent paperRoy Cordato of the John Locke Foundation happily takes on the role of critic as he dissects energy efficiency as a policy goal.

Dr. Cordato states in part:

It seems that no matter what governments at any level do, from building buildings to formulating and implementing legislation, “energy efficiency” has to be a consideration…. The problem is that the term, as defined by those who embrace it as a policy guide, is focused strictly on saving energy even if it means sacrificing overall economic efficiency.

Cordato draws a key distinction between energy efficiency and economic efficiency. Strictly speaking, energy efficiency is a type of technical or engineering efficiency focused on reducing one input, energy, in providing a given service or product. On the other hand, economic efficiency is a broad and all-encompassing concept that takes into account the relative costs of all inputs. Cordato explains:

[I]f using less energy, or more accurately, spending less money on energy, meant that the person had to invest in other equipment whose cost more than offset the savings, then even though energy efficiency might be enhanced, economic efficiency would be reduced. If the opposite were the case, mandates and special incentives programs would not have to be put in place to promote energy efficiency.

Of course, the reason why this is important for everyone is that minimum federal energy efficiency standards do exist for many household appliances, such as refrigerators, air conditioners, clothes washers/dryers, dishwashers, and more. Cordato highlights the logic of the regulator in enacting such policies:

To square this circle — in other words, to justify energy efficiency programs on the grounds of economic efficiency — proponents are indeed advancing the idea that the experts know better than the individual.

Where some see an “efficiency gap” that requires government intervention, Cordato sees an example of the classic pitfall of all central planners — the pretense of knowledge, the key concept from Friedrich Hayek’s 1974 Nobel Prize Lecture. Central planners (in this case, those who set energy efficiency standards) pretend to be in a better position than the individual to decide the relative merits of energy versus other inputs.

When advocates proclaim that it is “socially desirable” to promote energy efficiency through public policy — taxes, subsidies, mandates, etc. — they are saying that the tradeoff of higher equipment costs for less energy usage is worth it, from society’s perspective, even if it is a tradeoff that freely choosing individuals reject.

With Hayek’s insights on central planning in mind, which also bring to my mind Adam Smith’s concept of the “man of system,” it becomes clear that establishing energy efficiency standards boils down to paternalism. Cordato states:

Energy efficiency is rooted in the idea that some people, who have been labeled experts, believe that other people…are using “too much” energy and, by implication, not enough other resources in their production and consumption activities. It is an empirically and even conceptually unsupportable assertion. The reality is that energy efficiency requirements and programs are about substituting the so-called experts’ resource use preferences for the preferences of the people who actually purchase the resources and do the consuming and producing.

Policymakers would do well to internalize the time-tested lessons of Hayek and Smith and to pay attention when economists like Cordato expose major conceptual flaws in such wide-reaching policy goals as energy efficiency. If efficiency is the policy goal, the focus should be on economic efficiency, not energy efficiency.

Related Posts

The Conundrum – by David Owen (Jevons’ “rebound effect” enters the New Yorker mainstream)

Remembering the Birth of Conservationism (Part II: Amory Lovins’s “Soft Energy Path”)

Remembering the Birth of Conservationism (Part I: President Nixon’s price controls, not Arab OPEC, produced energy crisis, demand-side politicization)

Daylight Saving Time: Arrogant Central Planning

“Why Energy Efficiency Does Not Decrease Energy Consumption:” Comment on Harry Saunders

Demand-Side Management: Government Planning, Not Market Conservation (Testimony of Dan Simmons Before the Georgia Public Service Commission)

Coerced Energy Efficiency in Texas: Government Conservationism Isn’t Market Conservation

Inferior Holiday Lighting: Another Cost of the Futile Climate Crusade? (Malthusianism is gloomy in practice, not only theory)

“The Cheaper the Energy the Better” (Julian Simon in 1993 speaks to us today)

Market Conservation vs. Government Conservationism: Understanding the Limits to Energy Efficiency and ‘New-Economy’ ESCOs

17 comments

1 Jon Boone { 07.06.12 at 7:17 pm }

A timely, well-crafted post, reminding about how productivity is directly linked to modern power and the importance of accounting for all costs in any transaction. That energy efficiency does not equal economic efficiency, and vice versa, should go without saying. What does need saying is that reducing modern power capacity goes hand in glove with reducing productivity–and quality of life.

2 UzUrBrain { 07.06.12 at 9:08 pm }

Can anyone that frequents this site explain to me how I save energy by insulating my hot water pipes? I feel it is a complete waste of time, effort, materials, and money. Here is my logic:

In the morning the hot water in my bathroom (the longest run of pipe) will always be cold. I need to run the water about 15-20 seconds to get water hot enough to take a shower. I take my shower, and in less than 15 minutes my wife takes her shower.

We rarely use that hot water again until the next morning, and by then the water in that pipe is always cold. If ever used, we would only wash our hands and find the lukewarm water sufficient for that purpose. The amount of heat lost by the un-insulated pipe in transient is insignificant, almost immeasurable.

Likewise for the amount radiated to the surroundings. Besides, any energy that is radiated would help heat the house in the winter, and thus reduce my heating bill. Yes, in the summer this added heat would cause my air conditioner to run more, however, this would also help dehumidify the house and allow me to be comfortable at a lower temperature setting.

Besides, many newer air-conditioners now have humidity settings that add electric heat just so that the air-conditioner will run to bring down the humidity. The amount of even the best insulation (six plus inches of Styrofoam? as that is about all you could get between floors) needed to prevent any loss of heat to the surroundings overnight would be cost prohibitive. And I still don’t think you actually save any energy.

This reminds me of the story of the northern Canadian who replaced all of his light bulbs with CFL lights to save money and found that his oil bill went up by more than his electric bill went down. Seems that his incandescent lights were heating his house, and since he just opened the windows in the summer, he never noticed the heat from the lamps, which were not on as much then anyway.

3 Jon Boone { 07.07.12 at 12:14 pm }

UsUrBrain:
Nature is chock full of the kinds of inverse relationships you describe. As the old saying goes, in the long run, ya can’t fool mother nature. Hucksters can play shell games with her, however, fleecing the gullibly well intentioned by focusing attention on one shell (the insulated pipes) while the pea is safely tucked elsewhere (the radiated heat), exactly where the “smart” money is.

I once lived in an historic Victorian house, where the pipes to the add-on bathroom would freeze when the temperatures tucked below zero degrees F for a spell, causing me to lose time I could spend elsewhere, and reducing my quality of life. So I insulated where they no longer froze.

Here, the increased economic cost was justified, though, as you likely know, it didn’t reduce my electricity or gas bill (we heated with gas-fired water).

4 Johannes Kantelberg { 07.07.12 at 1:48 pm }

Those who advocate “energy efficiency” are knowingly or unknowingly perpetrating a huge con trick and seeming to be get away with it. They don’t take into account that perennial scourge of the environmentalists: human nature.

Works like this. An average family (99% of families fall into this category) is given 10,000 euros to insulate their house in order to save energy and “save the planet”. At the end of the year they find that they have used less electricity and gas and have saved 5,000 euros on bills.

What to they do? Being the average family, they like nothing better than spending their dosh. So, they buy a bigger car/TV/fridge etc. and/or fly to far away holidays, have more barbeques etc.

In the process, hallelujah, they increase their carbon footprint many times over. Just like the second law of thermodynamics say that heat cannot flow from cold to hot, the second law of economics says that government mandated energy efficiencies cannot reduce overall energy use.

5 David Bergeron { 07.07.12 at 11:48 pm }

This is a great post. I manufacture and sell high efficiency refrigerators and am keenly aware that there are a lot of inputs, including energy, necessary to make and deliver this product. Ignoring the cost of these for the sake of energy savings is risky business.

My target customer is the off-grid home owner, who is paying 40-60 cents/kWh for solar, wind, and diesel power. In this case the economics can make sense to pay more for a high efficiency product.

When approached by on-grid users, I try to encourage them to make the appliance choice which saves the most money. I think this also saves the most energy in the big picture. Often the energy star appliances don’t save enough to justify their cost. This is particularly true with high efficiency air-conditioners required to meet a SEER 14 rating, sold in climates like Reno Nevada where the units only run a few weeks a year. It is clearly a very poor investment, yet the government’s one size fits all mentality compels this waste of resources.

William Baumol wrote a paper titled “Subsidies to new energy sources, do they add to energy stocks?” He makes the case that since all goods are substitutable at the margin. $1 of copper can be used to save $1 in oil which can be used to save $1 in labor, etc. From this perspective saving money = saving energy.

A place where government mandates for energy efficiency can make sense is when one party pays for the appliance and another party pays for the electricity. A landlord may not have the same incentive to install an efficient appliance as the one paying the electric bill.

6 Michael Cunningham { 07.09.12 at 1:41 am }

The energy efficiency measures seem to ignore opportunity costs, and presumably are not based on cost-benefit analysis. In effect, they take the goal of energy conservation outside the market price system, which is better suited to optimising use of resources so as to increase overall well-being.

7 Thomas Wayburn { 07.09.12 at 9:10 am }

This article would make sense if the author’s background economic theory were correct, which it is not. While it is true that Jevon’s Paradox reduces the benefits of improved energy efficiency, it is also true that Jevon’s Paradox can be defeated by clever economic planning. But, the author’s principal problem is that he has not availed himself of the concept of eMergy (with an M) to evaluate energy efficiency properly.

8 Jon Boone { 07.09.12 at 9:43 am }

eMergy, indeed: http://www.emergysystems.org. How Darwinian! Yet another company exploiting a niche in the economic marketplace in the best predator/prey tradition. EEEP: Evaluating Energy Efficiency Properly. For a price.

Which of course reinforces Travis Fisher’s point….

9 David Bergeron { 07.09.12 at 10:05 am }

Thomas, using an emergy analysis makes no difference to the argument presented by Mr. Fisher. The emergy analysis is just an entropy analysis from a slightly different point of view and both forms of analysis ignore the non-energy value of labor, capital, and other raw materials which are properly captured in an economic analysis.

Emergy/exergy is mostly hype from the perspective of those that are already fluent with entropy analysis.

10 Thomas Wayburn { 07.09.12 at 11:40 am }

I have no idea what Jon Boone is talking about; but, Davis Bergeron should explain why the energy costs of equipment should not be part of the energy efficiency computation as the following passage suggests:

When advocates proclaim that it is “socially desirable” to promote energy efficiency through public policy — taxes, subsidies, mandates, etc. — they are saying that the tradeoff of higher equipment costs for less energy usage is worth it, from society’s perspective, even if it is a tradeoff that freely choosing individuals reject.

By the way, promoting public policy with taxes, mandates, and subsidies is like pushing on a string. What is needed is economic planning – possibly distributed – to completely replace all market activities. What’s that you say? The planners will become corrupt and economic planning will fail for that reason or other reasons. Someone had better figure out how to avoid the failures of the past and anticipate the difficulties of the future because market economics has already failed and, in any future manifestation, will consume too much energy.

But what did I expect the readers of this website to say!

11 Jon Boone { 07.09.12 at 3:13 pm }

Thomas Wayburn:
I’m sure David Bergeron will provide an excellent squelch to your leading question. As for me, I’ll say all contributing elements, and their various costs, should be factored into any transaction that purports to be “saving energy.” And this would include the cost of employing the services of Emergy–in order to “save” energy.

Why Jevon’s Parodox is so powerful as a descriptor of our modern dilemma is that it captures the element of human perversity that Fisher expounds upon here. Yes, human ingenuity might devise a means for doing the same amount of work using less energy. But then someone will soon deploy that means for, say, doubling that work, improving productivity (and profit) while conserving time–to do something else.

This is where the planning you represent, and perhaps profit from, founders. An ever expanding education that sheds light on the variables involved for producing any outcome is highly desirable. Planning in the sense of being aware of and generally prepared for consequence has been hard-wired into human DNA.

Planning in the sense of controlling all the variables, however, is rife with hubris. One doesn’t have to be a free marketeer to share Nassim Taleb’s schadenfreude, expressed so well in his Black Swan, about the many planning balloons that have been burst by the pricks of reality.

12 Eddie Devere { 07.09.12 at 7:23 pm }

Thomas,
Market capitalism has not failed yet because it still exists throughout the globe. But for that matter, communism or socialism have yet to fail because both exist in various forms across the globe.
The only thing we can probably agree on is that the Dodo bird and all of the dinosaurs have failed. It’s easier to agree on what happened in the past than it is to agree on what will happen in the future.

You are entitled to your opinion about the future. My bet is that market capitalism can outgrow communism and socialism in the long-run. Though, with that having been said, I realize that the fastest-growing economy in the world right now is China, which is a strange mix of capitalism and socialism. China seems to have somehow figured out how to solve the problem of excessive individualism in western capitalism and the problem of a lack of motivation to work in western socialism/communism.
We’ll see whether China is able to continue this phenomenal growth if/when its develops (1) an aging work force, (2) labor unions, (3) environmental rights groups, and/or (4) a religious/drug/anti-growth counter-culture.

Anyways, back to the topic at hand…
Travis,
The important variable is the rate of return on investment. It’s not energy efficiency or economic efficiency. It’s just the plain old rate of return on investment [%/yr]. I’m not sure what you mean by economic efficiency. You probably should have defined this term in the article.

Jon,
I agree with you. One should never use energy/emergy/exergy efficiency as the justification for building a power plant or buying a washing machine. One should ideally calculate the unsubsidized rate of return on investment in a free market.
(The exergy analysis is only useful for calculating the system efficiency of the power plant…which is one of the inputs into the rate of return analysis…so that you know fuel costs. The exergy analysis is slightly better than a first law analysis because it allows you to make sure that you aren’t violating the 2nd law in any of the steps within the power plant.)

13 David Bergeron { 07.09.12 at 9:20 pm }

Thomas, I’m not sure I am following you, but the energy cost of equipment should be a part of the calculation as well as all the other good and valuable inputs, such as copper, aluminum, steel, glass, labor, land, capital, etc. And these costs are best included using an economic analysis, not an energy or emergy/exergy analysis. The emergy analysis will ignore the energy opportunity costs of the non-energy inputs.

If you take the time to understand “The energy opportunity cost of non-energy Inputs,” I think you will find it a valuable investment. This is at the heart of why the energy/emergy analysis fails to count the energy value of the non-energy inputs.

$1 in labor really can substitute for $1 in oil. So spending $2 in labor (or copper or aluminum) to save $1 in oil is a bad move. Because if you try a little harder you will find that you can save $1 in oil with a $1 investment in other inputs. And when you run out of those opportunities, you will find other opportunities to save $1 in oil with just a $1.01 investment and so on.

But focusing on the energy/emergy inputs only is a classic error which dates back to the time of the Technocrats.

14 Travis Fisher: Economic Efficiency, Not ‘Energy Efficiency’ (Economist Cordato parses a sacred cow) | JunkScience.com { 07.10.12 at 3:36 am }

[...] MasterResource Share this:PrintEmailMoreStumbleUponTwitterFacebookDiggRedditLike this:LikeBe the first to like this. This entry was posted in Clean energy, Economics, Energy efficiency. Bookmark the permalink. ← Obama To Sign Anti-Second Amendment U.N. Gun Trade Treaty [...]

15 Thomas Wayburn { 07.11.12 at 2:33 am }

David,

Is the following passage an explanation for the passage that preceded it?

$1 in labor really can substitute for $1 in oil. So spending $2 in labor (or copper or aluminum) to save $1 in oil is a bad move. Because if you try a little harder you will find that you can save $1 in oil with a $1 investment in other inputs. And when you run out of those opportunities, you will find other opportunities to save $1 in oil with just a $1.01 investment and so on.

By “the passage that preceded it” I refer to the following:

If you take the time to understand “The energy opportunity cost of non-energy Inputs,” I think you will find it a valuable investment. This is at the heart of why the energy/emergy analysis fails to count the energy value of the non-energy inputs.

David,

I am willing to study “the energy opportunity cost of non-energy inputs” if you will be so kind as to provide a URL to point me in the right direction. I have been under the impression that I must convert all the inputs to a common basis if I wish to have a closed balance equation. Further, I still believe that I can convert every input to an energy basis. It’s interesting that your arguments seem to counteract arguments that some of my detractors have employed on other forums. Check the following for a quick look at my reasoning: http://dematerialism.net/eroeistar.htm

16 Recent Energy and Environmental News – 16th July 2012 « PA Pundits – International { 07.18.12 at 11:02 pm }

[...] interesting discussion of the economics of energy [...]

17 tfisher { 07.19.12 at 12:37 pm }

I apologize for the delay in responding.

Eddie, you can find a very thorough treatment of the concept of economic efficiency here (Cordato’s book on the subject): http://mises.org/document/3362. I agree that I should have defined and explained the approach to “economic efficiency” that we’ve taken here. Certainly other definitions exist, but this post focuses on Cordato’s view, which is rooted in the Austrian school of economics.

I disagree that return on investment is the proper variable to focus on because we are referring to broad public policy goals here, not individual investment choices per se.

Thomas, why not use dollars as your “common basis,” as David suggests? And to your point about the need for economic planning, you and I disagree on a fundamental level. I think planning should be done in a voluntary way on an individual level (coordinated through the price system, not by a central planner), whereas you seem to want to control the consumption decisions of others based on your judgment that their energy consumption is “too high.” As discussed above, I believe your position relies on a pretense of knowledge about what is “too much.”

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