Energy Efficiency Regulations Lambasted: Consumers are not Irrational, and Environmental Benefits are "Negligible"

 

Returning to American criticism, after the "world tour" of the last couple of posts.
I received this Working Paper, the authors may therefore make adjustments.

Overriding Consumer Preferences with Energy Regulations by Ted Gayer and W. Kip Viscusi, Mercatus Center, George Mason University, Arlington, Virginia, August 2012

The study is here (pdf document). An alternative link.
A summary (also a pdf document, and similar to the website page embedded below).


The study authors

Ted Gayer
tgayer@brookings.edu
Ted Gayer (more) is the co-director of the Economic Studies program and the Joseph A. Pechman Senior Fellow at the Brookings Institution.
He conducts research on a variety of economic issues, focusing particularly on public finance, environmental and energy economics, housing, and regulatory policy. He received his Ph.D. from Duke University.

W. Kip Viscusi
kip.viscusi@vanderbilt.edu
W. Kip Viscusi (more) is Vanderbilt’s first University Distinguished Professor, with primary appointments in the Department of Economics and the Owen Graduate School of Management as well as in the Law School.
He is the award-winning author of more than 20 books and 300 articles, most of which deal with different aspects of health and safety risks.
He received his Ph.D. from Harvard University.

Abstract

This paper examines the economic justification for recent U.S. energy regulations proposed or enacted by the U.S. Department of Energy, the U.S. Department of Transportation, and the U.S. Environmental Protection Agency.
The case studies include mileage requirements for motor vehicles and energy-efficiency standards for clothes dryers, room air conditioners, and light bulbs.

The main findings are that the standards have a negligible effect on greenhouse gases and the preponderance of the estimated benefits stems from private benefits to consumers, based on the regulators' presumption of consumer irrationality

Mercatus.org currently have a website summarizing the study: embedded below.




Society benefits are therefore seen as negligible, in what after all should be done for Society's good:
Consumers may make some enforced personal savings, from a ban on what they otherwise would have bought.

However, as the authors also point out, the assumed consumer irrationality is a mistake:
Consumers may have good reason to buy cheaper products for shorter or temporary usage, and the energy using products may have compensating features that consumers like - obvious enough, or they would not prefer them.
So what is called "benefits from correcting consumer irrationality" comes from additional purchases not otherwise made.
In simple English, having to buy what they otherwise would not buy.
[For more on the common regulator supposition of "market failure" and that people "only buy energy using products because they are cheap" and that "regulation is the only answer to this", see commenting below]

The authors also note the irony that new extensive information labelling requirements should provide the information that the EPA (Environmental Protection Agency), NHTSA (National Highway Traffic Safety Administration) and other responsible instances say that consumers lack when they need to make informed purchasing decisions.

Amongst case histories is a particular section on light bulbs.
The authors say
"DOE presents relatively little documentation on how it calculated the costs and benefits of the standard."
"No consideration was made for consumer preferences for different types of light bulbs or for such things as the rebound effect. Thus, the quality of light, whether the bulb is dimmable, and other aspects of light bulbs are irrelevant to the DOE assessment"


Edited extracts from the actual study [my added emphases again]:

Introduction

The efficiency rationale for any government regulation rests on the existence of some type of market failure.
The ways markets may fail are quite diverse, ranging from characteristics of the market structure to various kinds of externalities; that is, adverse effects on parties other than the buyer and seller of a product.

In the absence of some type of market failure there is no legitimate basis for regulation from the standpoint of enhancing economic efficiency.
The regulations are based on an assumption that government choices better reflect the preferences of consumers and firms than the choices consumers and firms would make themselves. They assume consumers and, in some cases, firms are incapable of making rational decisions and that regulatory policy should be governed by the myopic objective of energy efficiency to the exclusion of other product attributes.

Energy efficiency standards provide a valuable case study of how agencies can be blinded by parochial interests to assume not only that their mandate trumps all other concerns but also that economic actors outside of the agency are completely incapable of making sound decisions. The assumption that the world outside the agency is irrational is a direct consequence of the agencies’ view that energy efficiency is always the paramount product attribute and that choices made on any other basis must be fundamentally flawed.

They then examine the rationale for regulations,
comparing consumer need and society outcome...

The Energy-Efficiency Gap

The clearest regulatory example questioning consumer rationality is with respect to energy-efficient consumer goods, for which consumers frequently face a tradeoff of a higher upfront capital cost versus lower future operating costs over the life of the product.
A rational consumer will [supposedly] consider things such as the expected future cost of energy, the expected lifetime of the product, the frequency of use of the product, and the discount rate to convert future savings to present value compared to the up-front capital cost.

A long-standing empirical finding, known as the energy-efficiency gap, shows that consumer choices for energy-efficiency purchases imply a discount rate much higher than market discount rates, suggesting that consumers underweight the future cost savings stemming from an energy-efficient product compared to the weight they put on the future in other market settings...

[But] empirical evidence suggests that consumers’ valuation of the long-term differences in fuel efficiency for different models of cars may be quite reasonable.
In an econometric study of prices of used cars, Dreyfus and Viscusi estimated the rate of interest implicit in a consumer’s valuation of the discounted value of vehicle operating costs... [were] consistent with market rates.”
Unlike some engineering studies that purport to show that consumers neglect energy efficiency, this study considered a wide range of car attributes other than energy efficiency that are valued by consumers...
[Also] if you are planning to move or have a current liquidity problem, buying the more energy efficient but more expensive appliance may not make sense from an economic standpoint.....

[Similarly] Anderson and Newell find that manufacturing plants reject about half of the energy-efficiency projects recommended by engineering analyses because of unaccounted physical costs, risks, opportunity costs, lack of staff for analysis or implementation, risk of inconvenience to personnel, or suspected risk of problems with equipment.

By ignoring these relevant characteristics of the product, and the specifics of the customer’s economic circumstances, the engineering studies can arrive at incorrect findings of personal savings from the products that have higher up-front costs but yield lower operating costs.
Since the engineering studies focus only on capital costs and operating costs, they do not allow for any heterogeneity of preferences and use of products across consumers.
Another possible explanation for the findings of apparently high consumer discount rates in engineering studies is that consumers do not expect to receive as high a return in energy savings as the analyst assumes.
The regulatory agencies [therefore] frequently rely on engineering studies that presume consumers can accrue benefits by regulatory standards that restrict consumption choices.

Taken as a whole, the engineering and empirical literature on the energy-efficiency gap does not provide strong, credible evidence of persistent consumer irrationality.

Providing accurate information to consumers would be preferable to regulatory mandates.
Indeed, Executive Order 12866 (signed by President Clinton and re-affirmed by President Obama in his Executive Order 1356316) requires each agency to “identify and assess available alternatives to direct regulation, . . . such as . . . providing information upon which choices can be made by the public.”
Informational efforts can and do provide energy-cost information over the lifetime of the appliance.

They then go on to "analyze documentation used to support energy efficiency regulations promulgated by DOE, EPA, and DOT" for different products.

Case Studies

CAFE Standards for Passenger Cars and Light Trucks
One does not have to be a reader of automobile reviews in Edmunds.com, Car and Driver, or Road and Track to realize that fuel efficiency is but one of many factors people use to assess the quality of an automobile.
Acceleration, handling, braking ability, legroom, riding comfort, safety, reliability, styling, and trunk storage are among the many other dimensions of concern to automobile purchasers.
Despite the NHTSA (National Highway Traffic Safety Administration) admission that it is uncertain whether the lack of market demand for higher fuel economy is due to consumer irrationality or consumer preferences, it proceeds to promulgate a regulation that assumes the former.

[NHTSA and EPA] justifications largely amount to problems of inadequate information, such as the reasoning that fuel-economy benefits are not salient enough to consumers, that consumers have difficulty calculating expected fuel savings, or that consumers might associate higher fuel
economy with inexpensive, less well-designed vehicles.
[This] raises the question of why a rigid mandate is warranted rather than an informational regulation that would provide consumers with the guidance to make sounder choices.
Indeed, in 2011 EPA did just that by issuing its Motor Vehicle Fuel Economy Label Final Rule. The mandated label for all new cars is quite extensive, including an overall mpg rating, a city mpg rating, a highway mpg rating, gallons/100 miles, driving range on a tank of gas, fuel costs in five years versus the average new vehicle, annual fuel costs, fuel economy and greenhouse-gas rating, and smog rating.

What is striking about the EPA analysis of the CAFE standard is [therefore] that the EPA regulatory impact analysis does not even mention the existence of the agency’s own new label rule.
This oversight goes to the heart of the CAFE standard analysis, as most of the benefits needed to justify the regulation relate to consumer choice failures targeted by the new labeling..

The agencies that regulate these standards—the National Highway Traffic Safety Administration and EPA—estimate greenhouse-gas benefits make up less than 10 percent of the total claimed benefits. But when benefits are restricted to only the United States, they drop to just over 1 percent of total claimed benefits.


Clothes Dryers, Air Conditioners, Clothes Washers
DOE estimates the global greenhouse-gas emissions benefits of clothes dryer standards as between $93 million and $1.49 billion which is below the estimated private benefits range of $1.08 billion to $3.01 billion.
DOE estimates the global greenhouse-gas emissions benefits of room air conditioner standards as between $77 million to $1.16 billion as compared with the estimated private benefits range of $570 million to $1.47 billion.

An earlier proposed regulation of clothes washers was purported to have great energy savings for consumers, but a Rasmussen Research poll found tremendous consumer opposition to the standard.By a margin of 6 to 1 the public opposed regulations that would effectively eliminate top-loading washing machines.
Much of the opposition arose because most consumers wash fewer loads per week than the DOE analysis assumed; for this group the present value of the cost savings is far less than the estimated savings.
Engineering studies divorced from consumer usage and preferences can produce policies that produce far fewer benefits than predicted.


Other Appliances
Acting under authority from EPCA, DOE has promulgated energy-efficiency regulations for other appliances as well.
For example, DOE issued standards for residential refrigerators in 2011, and for industrial products, such as high-intensity light fixtures (known as metal halide lamp fixtures) and walk-in coolers and freezers in 2012.
As in the case of the fuel-economy standards, for each of these appliance standards, the preponderance of the estimated benefits consists of [supposed] private benefits to the purchasers of the products:
There must be some form of individual irrationality or behavioral shortcoming of individual choices to give rise to these benefits. DOE provides little, if any, analysis and documentation of this assumed irrationality in its rules.

Not forgetting light bulbs...

General Service Incandescent Lamps

DOE presents relatively little documentation on how it calculated the costs and benefits of the standard.
The DOE analysis calculated cumulative national energy savings as the sum of annual national energy savings, which in turn was estimated as the difference in annual national energy consumption between the base case and the case with the new General Service Incandescent Lamps (GSIL) standards.
DOE estimates 14.14 quads in cumulative national energy savings.
The net present value to consumers is computed as the present value of operating-cost savings minus the present value of increased total installed costs.

DOE computed the operating-cost savings for a given year by multiplying the surviving stock of GSILs of a given vintage in that year by the per-unit operating-cost savings for that vintage (obtained by multiplying the vintage’s expected energy savings by forecasted energy prices), then summing over vintages.
DOE computed increased total installed costs for a given year by researching product catalogs, online distributors, and manufacturing interviews to estimate “the increase in unit prices for products that comply with EISA 2007.”
It then multiplied the surviving stock of GSILs of a given vintage in that year by this annual per-unit total-installed cost increase, then summed over vintages.

No consideration was made for consumer preferences for different types of light bulbs or for such things as the rebound effect.
Thus, the quality of light, whether the bulb is dimmable, and other aspects of light bulbs are irrelevant to the DOE assessment.

DOE’s net present value estimate is for $27.5 billion (7 percent discount rate) or $64.2 billion (3 percent discount rate) in cumulative savings to consumers from 2008 through 2038 stemming from the efficiency standards for light bulbs.
These estimates of private benefits far outweigh DOE’s estimate of between zero and $16.34 billion in benefits from reducing carbon dioxide emissions.
Once again, [supposed] private benefits to consumers drive the economic justification for the analysis.

Conclusion

The economic puzzle raised by all these energy regulations is why consumers are this remiss.
How can it be that consumers are leaving billions of potential economic gains on the table by not buying the most energy-efficient cars, clothes dryers, air conditioners, and light bulbs?
Moreover, how can it also be the case that firms seeking to earn profits are likewise ignoring highly attractive opportunities to save money?
If the savings are this great, why is it that a very basic labeling approach cannot remedy this seemingly stunning example of completely irrational behavior?

It should be quite simple to rectify decisions that are this "flawed".
It should be a red flag that something is amiss with an analysis that assumes such perplexing consumer and firm behavior that runs counter to the most rudimentary economic theory and our general sense that we do not live in a world in which people never make sound choices.

It might be that there is something that is incorrect or perhaps even irrational in the assumptions being made in the regulatory impact analyses.
Indeed, upon closer inspection it is apparent that there is no empirical evidence provided for the types of consumer failures alleged.
Even if some consumers do sometimes fall short on certain dimensions of choice, the magnitude and prevalence of such a shortfall is important and is never addressed in the regulatory assessments. Nor is there adequate consideration of the actual and potential role of informational remedies that have already been adopted.

Perhaps the main failure of rationality is that of the regulators themselves.  [!]
Agency officials who have been given a specific substantive mission have a tendency to focus on these concerns to the exclusion of all others.
Thus, fuel efficiency and energy efficiency matter, but nothing else does.
If other attributes matter, it is assumed they either are irrelevant or will be included at no additional cost in the post-regulation products. In effect, government officials act as if they are guided by a single mission myopia that leads to the exclusion of all concerns other than their agency’s mandate.
Institutional biases of this type are common and are fundamental characteristics of organizational behavior. Indeed, the existence of parochial visions by agencies is a major reason the Executive Office of the President has institutionalized a formal regulatory oversight process beginning with the Ford administration and including a BCA [Benefit Cost Analysis] test since the Reagan administration.
One question raised by these analyses is whether the legislation mandating these standards permits OMB [Office of Management and Budget] to provide credible evidence of the market failures pivotal to justifying the regulations.

Adopting a more accurate economic analysis does not imply that government agencies do not have any policy tools that can be used to foster greater energy efficiency.
Informational policies and more limited forms of policy intervention may be warranted on a benefit-cost basis.
Recent regulatory analyses demonstrate that the current energy-efficiency initiatives do very little to address climate change. Rather than squander societal resources on more ineffective policy efforts, a more productive approach would be to search for policy options that offer greater potential for making a serious dent in greenhouse-gas emissions.

Even the modest environmental benefits are overstated because they are based on projected benefits to the world — not just to citizens of the United States.

Comment

A further note on the supposition that "there is a market failure that requires regulations".
Market failure is the underlying reason for regulations, in other words that consumers are not voluntarily buying the "right" products, and so the markets have "failed".

As the study authors point out,
the concept of market failure is questionable, in that consumers may have rational reasons for buying what they do:
- either in that the overall cost may be too high for short term or temporary use,
- or that the product may have other desirable features attracting a purchase
These issues are also extensively covered here, regarding the exemplified effect of
regulatory standards on product characteristics, product price and usage savings, http://ceolas.net/#cc21x.

A common follow-up by "market failure" advocates is that people only buy the products because they are "cheap", not because of any useful features:
Therefore, people should be "happy" in being pushed or forced to make purchases "expensive to buy but cheap in the long run".
However, people do buy many other products which are virtually identical except that the expensive kind "is cheaper in the long run", as illustrated with the battery and washing up liquid examples in the Deception of Light Bulb Ban Arguments rundown on this site.

Also more generally do people buy expensive product versions, or they would not be on the market.
In fact, that is precisely the situation with energy saving alternatives, as with the CFL and LED and Halogen alternatives relevant in the context of this blog, and as both American (DoE) and EU (EcoDesign) research has shown:
Most have some of these in their households already - but they obviously don't want all their lighting to be of such kind.
How hard can it be to understand this?


Again, even if it is accepted that "something must be done" to correct the supposed market failure, then, as the authors suggest, better information is the first line of action, informational labelling that has just been introduced in new extensive forms in both the USA and EU (as with light bulbs), and that therefore could be given time to act, again echoing what the authors say.

Ignoring that, regulation is still not the answer to save electricity:
As covered in point 13 of the mentioned Deception rundown.
In other words, stimulation of market competition, or taxation-subsidy policies.

Stimulated market competition involves helping new inventions to market, but without continuing subsidies.
With electricity, it also involves the increased competition of service providers in the grids, thereby using their energy resources efficiently under market pressure - without regulation.

Market Competition and Taxation-Subsidy policies as alternative to Regulations, using Light Bulb example: http://ceolas.net/#li23x.

Taxation is not the best option, but is interestingly and oddly shunned also by liberal pro-regulator tax-and-spend politicians: As said it can pay for price reductions on energy saving alternatives, so people are "Not Just Hit By Taxes".


Bankrupt California has seemingly got round to asking the electorate
"How you want to be taxed, as increased taxation is now a necessity".

Well now!
There is hardly a less painful way to achieve government income than to base energy standards on taxation rather than regulation, be it building construction, cars, washing machines, TV sets, light bulbs etc, given the plethora of current bans accompanied by subsidies to utilities and manufacturers.
It allows such subsidies to be covered, or of course other Government spending, while ensuring greater consumer choice.
Environmental targets are still kept as desired, a high tax simulates a ban, while intermediate levels give high government income for compensatory "Green" measures.

No - taxation is not the best option.
But it is yet another way that the supposition "market failure requires regulation" is wrong:
if there actually is a "market failure" when people are allowed to buy what they want!


Perhaps one day the officials pursuing bans or "energy usage based phase outs" of popular useful products will start to think about what they are doing.
The question is, when.