“The difficulty in getting people to participate in the federal weatherization program, even with significant incentives and strong encouragement, as well as the negative private and social rates of return realized, suggests that extent of the market failure, if it exists at all, is substantially overblown.”
Government intervention in the name of energy efficiency provisions often enjoys bipartisan support. Relying more on engineering than real-world economic analysis, proponents argue that there is an energy efficiency gap in which individuals and firms forego such investments that would provide both private and social benefits, the latter via negative externalities associated with energy use.
Government programs, it is argued, can eliminate this market failure. But like most government programs, the benefits of government-driven energy efficiency are often far less than promised.
Market vs. Government Decision-Making
Investing in energy efficiency can be beneficial. Where efficiency can be pursued in a cost-effective manner, as perceived by the relevant decision-makers, taking into account time preference, imperfect knowledge, and transaction costs, it makes sense to do so because the energy savings frees resources for other pursuits.
However, if government efficiency programs ignore or underestimate costs or overestimate potential benefits, they can reduce welfare. Pursuing misguided energy efficiency investments misallocates resources away from other productive, welfare-enhancing investments.
For example, firms use many inputs in their production processes, not just energy, but labor, machinery, raw materials, etc. The goal of a firm is to achieve overall efficiency, not just the efficient use of single input. If the cost of labor is particularly high, a firm may decide to invest in more energy-consuming machinery to increase labor productivity and reduce the size of its labor force. In other words, the firm seeks the most efficient mix of inputs based on the relative prices of those inputs.
One example from history. In the 19th century, Europe considered American woodworking machinery the best in the world. But Europeans did not adopt it because it was wasteful. Using wood-consuming but labor-saving machinery in Europe didn’t make sense where wood there was scarce and expensive, while labor was plentiful and cheap.
The opposite was true in America. Americans and Europeans both achieved overall production efficiency by using different mixes of input factors based on their relative prices.[i] A government program to increase the efficient use of wood in the 1800s would have been nonsensical.
New Economics Study
A paper presented at the American Economic Association’s annual meeting earlier this year, “Do Energy Efficie3ncy Investments Deliver? Evidence from the Weatherization Assistance Program,” evaluated the cost effectiveness of the Federal Weatherization Assistance Program. The researchers randomly selected 7,500 of 29,000 eligible households in Michigan and invited them to participate in the program. They also offered assistance with the application process. The resulting variation in participation gave the researchers the ability to determine the average effects of these energy efficiency investments on energy consumption.
The research resulted in several interesting findings.
The difficulty in getting people to participate in the federal weatherization program, even with significant incentives and strong encouragement, as well as the negative private and social rates of return realized, suggests that extent of the market failure, if it exists at all, is substantially overblown. Indeed, the authors know they are challenging the “conventional wisdom” of “the energy efficiency gap.” It will be interesting to see how the paper presented above is revised for publication.
[i] Nathan Rosenberg, “America’s Rise to Woodworking Leadership,” in Perspectives in Technology, Cambridge University Press, 1976.