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 paper, Roy 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.