Tag Archives: Energy Efficiency

Thinking like an Economist Means Thinking about Tradeoffs

This week, I’ve written two articles about different types of tradeoffs that economists think about when they evaluate the likely effectiveness of proposed public policies. One type of tradeoff relates to the costs that consumers and businesses incur in exchange for the benefits policies will achieve, while a second type of tradeoff involves countervailing risks that sometimes increase as policies aim to reduce other risks.

An example of the first type of tradeoff, involving benefits and costs, comes from energy efficiency regulations for appliances. These regulations do produce some benefits involving reduced emissions, but entire classes of very important costs are routinely overlooked by regulatory agencies. When an agency doesn’t count what consumers give up in exchange for the good things policies produce, there is a greater chance people will be made worse off by a policy. That’s bad news.

Here is a relevant portion of an op-ed I wrote published in the Washington Times:

The Department of Energy sets energy conservation standards that limit the amount of electricity that can be used by home appliances like refrigerators and air conditioners. These sweeping regulations affect nearly every American consumer. The department claims its rules address an imminent problem — environmental degradation — and argues that its conservation rules produce two main benefits: First, more energy-efficient appliances use less energy, so we all release fewer emissions into the atmosphere. Second, by using less energy, consumers may save money over time on monthly utility bills.

Sounds like a win-win situation, right? Not so fast.

We haven’t considered the costs of these regulations. Consumers care about their utility bills and the environment, but they also care about how well a product works, its appearance, whether the product comes with or without a warranty, the purchase price, and countless other things. When product attributes change as a result of regulations, these are costs to consumers. But the costs are ignored by regulators at the Energy Department. Regulators do consider some costs, like how much more appliance makers will have to pay when they are forced to comply with new rules, but the costs to consumers — whom we should care most about — are systematically overlooked.

In a second article, published in US News and World Report, I show how tradeoffs can involve more than just benefits and costs (which are valued in monetary terms). Tradeoffs can also involve risks. An example of a risk tradeoff comes from proposed legislation in New Jersey that targets distracted driving. The bill would ban drivers from engaging in “any” activity unrelated to driving that might interfere with the safe operation of a vehicle in the state. Some have said the bill’s language is so expansive that drinking a cup of coffee while driving would be banned.

The distracted driving bill has the potential to create what economists call “risk tradeoffs,” which occur when the mitigation of one risk simultaneously increases the risk of another. This bill addresses an all-too-real danger, but any law that prevents people from drinking coffee behind the wheel is going to increase at least one other risk: the risk created by drowsy drivers on the roads.

With fewer people drinking coffee on the roads, that means more sleepy truck drivers hauling sixteen wheelers at 2am. Is that a risk worth bearing in exchange for fewer distracted drivers? That’s a difficult question that will involve careful analysis to answer.

Risk tradeoffs are actually pretty ubiquitous, and involve far more than just Jersey drivers.

One of the most common ways new policies create risk tradeoffs is through “substitution effects.” For example, when a pesticide is banned, farmers usually switch to a different pesticide instead. The new chemical may be safer than the banned one, but it could also be more dangerous. Sometimes risks are simply shifted from one group of people to another. A new pesticide might reduce the risk from eating residue left on fruit in the supermarket, but at the same time, it could create new risks for farmers who work among the sprayed fruit.

Considering these kinds of tradeoffs—benefit/cost and risk/risk—is what rational decision making is all about. Any good economists is trained to think about these things when evaluating proposed policies. If legislators and regulators are going to use the resources we entrust them with wisely, we should all demand they think like economists too.

Energy Efficiency as Foreign Aid?

A recent suite of energy efficiency regulations issued by the Department of Energy (DOE) have been criticized due to the DOE’s claim that consumers and businesses are behaving irrationally when purchasing appliances and other energy using devises. The Department believes it is bestowing benefits on society by “correcting” these faulty decisions. Mercatus Center scholars have written about this extensively here, here, and here.

However, even if we set aside the Department’s claims of consumer and business “irrationality,” a separate rationale for these regulations is also very problematic. The vast majority of the environmental benefits of these rules stem from reductions in CO2 emissions due to lower emissions from power plants. However, in a 2010 report, the US government estimated only 7 to 23 percent of these benefits will be captured by Americans. The rest will go to people in other countries.

Here’s a recent example. In August, the DOE proposed a rule setting energy efficiency standards for metal halide lamp fixtures. In the agency’s analysis, it estimated total benefits from CO2 emission reductions at $1,532 million. Using the more optimistic estimate of the percentage of CO2 related benefits going to the US citizens (23%), Americans should capture about $450 million in environmental benefits from the rule (once we include benefits from reductions in NOx emissions as well). At the same time, the DOE estimates the rule will cost $1,294 million, much of which will be paid by American consumers and businesses. How can the DOE, which is tasked with serving the American public, support such a policy?

One might argue America is imposing costs on the rest of the world with its carbon emissions, and therefore should pay a type of tax to internalize this external cost we impose on others. However, the rest of the world is also imposing costs on us. In fact, US emissions are actually in decline, while global emissions are on the rise.

Even if we assume it is a sensible policy for Americans to compensate other countries for our carbon emissions, is paying for more expensive products like household appliances the best way to accomplish this goal? Given that no amount of carbon dioxide emission reductions in the US will do much of anything to reduce anticipated global warming, wouldn’t the rest of the world be better off with resources to adapt to climate change, instead of (at best) the warm feeling they might get from knowing Americans are buying more expensive microwave ovens? A more efficient policy would be a cash transfer to other countries, or the US could create a fund the purpose of which would be to help other countries adapt to climate change.

Energy efficiency regulations from the DOE are already difficult enough to justify. Knowing they are really just a roundabout form of foreign aid makes these rules look even less sensible.

Do Energy Efficiency Regulations Create Jobs?

Earlier this year, the Department of Energy (DOE) finalized a regulation setting energy efficiency standards for microwave ovens. At the time, Heather Zichal, the Deputy Assistant to the President for Energy and Climate Change, had this to say about the regulation:

…in his State of the Union Address this year, the President set a bold new goal: to cut in half the energy wasted in our homes and businesses over the next 20 years. Part of how we will achieve that goal is by making appliances more energy efficient. Not only will that help Americans keep more money in their pockets, it will also curb pollution and spark innovation that creates jobs and ultimately brings better products to the marketplace. That’s why we are proud to announce today that the Department of Energy has finalized new energy efficiency standards for microwaves… (emphasis added)

I’ve written elsewhere about why Americans should be skeptical of the environmental benefits from this regulation, as well as other energy efficiency regulations emanating from the Department of Energy. Putting that aside for a moment, I’d like to focus on the last part of Ms. Zichal’s comment, that energy efficiency regulations will create jobs.

As an example, let’s look at the microwave oven regulation that Ms. Zichal cites in her blog post. According to the Department of Energy’s own employment analysis, the employment effects of this regulation are negligible. Since American consumers import roughly 99% of microwaves purchased, the DOE expects that effects on domestic production jobs will be virtually zero.

In addition, DOE models indirect employment effects on other industries as a result of changes in consumer behavior and investment decisions resulting from the regulation. While these numbers are highly uncertain given the inherent difficulty in predicting these things, the DOE estimated the rule will probably eliminate jobs in the short term, estimating between 551 jobs destroyed and 17 jobs created by 2016. In the long run, employment effects may be positive, with the regulation potentially creating between 153 and 697 jobs by 2020. However, the DOE notes there are limitations inherent in its model when calculating these effects, especially when trying to predict jobs created years in the future. For example, the DOE states:

Because [the agency’s model] does not incorporate price changes, the employment impacts predicted by [the model] would over-estimate the magnitude of actual job impacts over the long run for this rule.

The DOE goes on:

…in long-run equilibrium there is no net effect on total employment since wages adjust to bring the labor market into equilibrium. Nonetheless, even to the extent that markets are slow to adjust, DOE anticipates that net labor market impacts will be negligible over time due to the small magnitude of the short-term effects.

Creating jobs should never be the primary reason for justifying a regulation.  In most cases, jobs created by regulations are compliance jobs, which constitute a cost of regulating, not a benefit. More importantly, these types of predictions about jobs created and destroyed ignore the true employment costs of regulation that occur when individuals lose their jobs because of a rule. These costs include things like lost earnings, loss of health insurance, stress, additional health effects, etc. Despite this, by the DOE’s own estimates job creation does not appear to be a solid justification for this particular energy efficiency standard.

Should Regulation Prohibit Self-Penalizing Behavior?

Last weekend, a guy ordered the “Sourtoe Cocktail” at a hotel bar in Dawson City in the Yukon.  The drink is garnished with a real (preserved) human toe. The patron downed the drink, deliberately swallowed the toe, then paid the bar a $500 fine for swallowing the toe.

sour toe

Photo credit: Philippe Morin/CBC

This is the kind of anecdote that would prompt health and safety advocates in that less-civilized country south of the border (the United States) to call for a new regulation — probably one prohibiting the use of human body parts in cocktails. In my humble opinion, the story is a good example of why it’s a waste of government’s time to regulate against behavior that carries its own penalty.

In fact, there’s a double penalty in this case. First is the yuk factor.  I wouldn’t order a drink with a toe in it, much less swallow the garish garnish.  Second is the monetary fine imposed by the bar. And the bar subsequently raised the fine to $2500, since now the establishment has to pull a backup toe out of mothballs. (Presumably that’s the one on the plate of salt in the photo.)

That double-whammy already ensures that swallowing a toe in one’s drink will be a rare occurrence. Yet there is still some risk that it will happen again; a precautionary approach would suggest that a new regulation is indeed needed unless the drink can be proven absolutely safe.

The tale of the Sourtoe Cocktail is a fanciful (but real) example of self-penalizing behavior that is (apparently) not yet prohibited by the Canadian government. The U.S. government, however, has seen fit to enact regulations prohibiting much more mundane behavior that carries its own penalty.

For example, consider energy efficiency standards for appliances used by consumers and businesses. These standards effectively ban the sale of appliances that cost more to operate because they use more electricity or gas. Energy efficiency can have environmental benefits, but in many cases, most of the benefits the government claims for energy efficiency standards come in the form of lower energy bills for the users. In other words, the decision to buy a less-efficient washing machine, furnace, or refrigerator carries its own penalty in the form of higher energy costs.

The Department of Energy’s proferred justification for these regulations is that consumers harm themselves by placing too low a value on the future energy savings. That’s a debatable point that Ted Gayer and Kip Viscusi have amply dealt with in a recent study supported by the Mercatus Cetner and published in the Journal of Regulatory Economics. My colleague Sherzod Abdukadirov listed a bunch of regulations that employ similar logic in his recent post.

Even more questionable is the regulation regarding commercial washing machines that I reviewed for the Mercatus Regulatory Report Card. The Notice of Proposed Rulemaking for this regulation seriously argued that greedy, profit-oriented businesses would leave money on the table by refusing to invest in cost-saving, energy-efficient washing machines that would generate a high rate of return due to the energy savings!

With all the ways people find to harm each other, do we really need regulators to police behavior that carries its own penalty?

Where Are The Benefits From Recent Energy Efficiency Regulations?

On Tuesday, President Obama gave a speech announcing his new agenda to combat climate change. As part of his efforts to curb greenhouse gas emissions, the President and his administration plan on releasing a series of energy efficiency regulations, supposedly with the intention of reducing carbon dioxide emissions. The problem is, the vast majority of the benefits from many energy efficiency rules have nothing to do with reducing carbon dioxide emissions, and this is according to the government’s own estimates. Instead, agencies like the Department of Energy (DOE) are eliminating options for consumers, and then counting the loss to consumers as a benefit of regulating.

How do they do this? It all has to do with a relatively new field of social science known as behavioral economics. You can think of behavioral economics as the intersection of psychology and economics. Behavioral economists believe that people exhibit many biases that cause them to systematically act in ways that are out of line with their true preferences. In a lab situation, there are many examples of such biases that have been demonstrated. For example, a person buying a home may bid one price, but if she is selling the same house, she may require a higher price, implying she values the same object differently depending on whether the object belongs to her or not. Or, people may value objects differently depending on time. For instance, a person might choose to receive $100 today over $110 tomorrow, yet at the same time pass on $100 a year from now in exchange for $110 in a year and one day, implying the person is more impatient today than he sees himself being in the future.

As the chart below demonstrates, the Department of Energy recently finalized a regulation related to microwave ovens, and nearly 80% of the benefits of the rule stemmed, not from protecting the environment or public health, but from saving consumers money by preventing them from buying the products they would choose otherwise. DOE does not seem to understand why consumers might choose to pay a relatively low price today for a product that is not very energy efficient, when this person could buy a more expensive energy efficient product that will save money over the life of the product through lower electricity bills. From an economics perspective, DOE does not believe this behavior is rational, hence it is like one of the behavioral biases described above, and in many cases DOE has decided to ban the products it doesn’t like in order to protect consumers from themselves.

Energy Efficiency Benefits from DOE Microwave Ovens Regulation*

Capture4

Federal agencies are ignoring the fact that consumers may value other attributes of products aside from energy and fuel efficiency. With automobiles, consumers may prefer larger and safer cars, to smaller more fuel efficient vehicles. Restaurants may prefer light bulbs that raise electric bills slightly every month, but whose warm glow creates an ambiance that customers enjoy. And in the case of microwaves and laundry machines, it may be that machines that use more energy simply work better at their stated purpose. And it’s not just microwave ovens. DOE, and other agencies like the Department of Transportation and the Environmental Protection Agency, make this same type of assumption with other regulations, like rules impacting commercial clothes washers, light bulbs, and fuel efficiency standards for vehicles. Agencies even assume businesses are behaving in this manner. Does anyone honestly believe that trucking companies aren’t taking fuel efficiency into account when buying new fleets? Or that laundromat owners don’t consider electricity costs when purchasing new equipment? It seems highly implausible, but agencies are assuming just that.

For decades, agencies have been required to identify a market failure or other systemic problem that exists before intervening in the marketplace with a regulation. Market failures include things like a lack of competition, a lack of consumer information, or costs that spill over onto the public as the result of a private transaction. Now, agencies like DOE have begun to expand the definition of market failure to include what they deem to be personal failures on the part of consumers.

So why are agencies doing this? One reason may be because the environmental benefits alone aren’t enough to justify the costs of some regulations. Claiming additional benefits helps agencies justify an inefficient policy, and keeps government programs continuing to employ regulators. Agencies have other ways to make the benefits of rules appear greater too. In the case of the microwave rule, of the small portion of benefits related to carbon dioxide reductions, most will be captured by citizens of foreign countries, with only a small fraction going to US citizens. Counting benefits to foreigners makes the benefits of rules appear greater, even though agencies are asked to only consider benefits to the United States in most cases.

Another reason we may be getting these types of rules is the rules may really be intended to benefit special interest groups more than consumers. A manufacturer that is already producing an energy efficient product may capture market share by getting the products of its competitors banned. Or manufacturers may simply want to force consumers to buy a more expensive product, or replace old products with new ones, while eliminating the possibility of a competitor undercutting them by selling a cheaper product in the marketplace.

Reducing Carbon Dioxide emissions in order to combat climate change may be a noble goal, but recent energy efficiency regulations are unlikely to get us there. Rather than overriding consumer choice, and counting this loss to consumers as a benefit, DOE and other agencies should give the American people a more honest assessment of the benefits of their rules.

* Source: Department of Energy, “Technical Support Document: Energy Efficiency Program for Consumer Products and Commercial and Industrial Equipment: Residential Microwave Ovens – Stand-By-Power,” (Table 1.2.1.), May 2013. Calculated using a 3 percent discount rate. Assumes 15 percent of reductions in CO2 emissions are attributed to the United States. This is the midpoint between 7 percent and 23 percent, the range estimated by the Interagency Working Group on Social Cost of Carbon, “Technical Support Document, Social Cost of Carbon for Regulatory Impact Analysis under Executive Order 12866,” February 2010.