Economic Policy Archives - Page 31 of 39 - An Economic View of the Environment

Assessing the Energy-Efficiency Gap

Global energy consumption is on a path to grow 30-50 percent over the next 25 years, bringing with it, in many countries, increased local air pollution, greenhouse gas (GHG) emissions, and oil consumption, as well as higher energy prices. Energy-efficient technologies offer considerable promise for reducing the costs and environmental damages associated with energy use, but these technologies appear not to be used by consumers and businesses to the degree that would apparently be justified, even on the basis of their own (private) financial net benefits.

For some thirty years, there have been discussions and debates about this phenomenon among researchers and others in academia, government, non-profits, and private industry, typically couched in terms of potential explanations of the so-called “energy efficiency gap” or “energy paradox.”

Thinking About the Energy-Efficiency Gap

I wrote about this some two years ago at this blog (Thinking About the Energy-Efficiency Gap). I noted then that Professor Richard Newell of Duke University and I had just launched an initiative – sponsored by the Alfred P. Sloan Foundation — to synthesize past work on potential explanations of the energy paradox and identify key gaps in knowledge. We subsequently conducted a comprehensive review and assessment of social-science research on the adoption of energy-efficient technologies.

We worked with leading social scientists — including scholars from economics, psychology, and other disciplines, at a workshop held at Harvard — to examine the various possible explanations of the energy paradox and thereby to help identify the frontiers of knowledge on the diffusion of energy-efficient technologies. As materials became available, we posted them at the project’s Harvard website and the project’s Duke website.

Releasing a New Monograph

I’m pleased to inform readers of this blog that we have now released a major monograph, Assessing the Energy Efficiency Gap, co-authored with Todd Gerarden, a Harvard Ph.D. student in Public Policy and a Pre-Doctoral Fellow of the Harvard Environmental Economics Program (HEEP). The monograph draws in part from the research workshop held at Harvard (in October 2013), in which most of the U.S.-based scholars (primarily, but not exclusively, economists) then conducting research on the energy-efficiency gap participated. HEEP co-sponsored a second such research workshop with the Centre for European Economic Research (ZEW) in Mannheim, Germany in March 2014, where European economists explored the same topic. Closely-related research was presented by panelists at the annual conference of the Allied Social Science Association in January 2015.

In the new monograph, Gerarden, Newell, and I examine both the “energy paradox,” the apparent reality that some energy-efficiency technologies that would pay off for adopters are nevertheless not adopted, and the broader phenomenon we characterize as the “energy-efficiency gap,” the apparent reality that some energy-efficiency technologies that would be socially efficient are not adopted. The contrast is between private and social optimality, which ultimately has important implications for the role of various policies, as well as their expected net benefits.

Four Key Questions

We begin by decomposing cost-minimizing energy-efficiency decisions into their fundamental elements, which allows us to identify four major questions, the answers to which are germane to sorting out the causes (and reality or lack thereof) of the paradox and gap.

First, we ask whether the energy efficiency and associated pricing of products on the market are economically efficient. To answer this question, we examine the variety of energy-efficient products on the market, their energy-efficiency levels, and their pricing. Although the theory is clear, empirical evidence is—in general—quite limited. More data that could facilitate potential future empirical research are becoming available, although firm-level data are much less plentiful than data on consumers. We do not see this area as meriting high priority for future research, however, with the exception of research that evaluates the effectiveness and efficiency of existing energy-efficiency information policies and examines options for improving these policies.

Second, we ask whether energy operating costs are inefficiently priced and/or understood. Even if consumers make privately optimal decisions, energy-saving technology may diffuse more slowly than the socially optimal rate, because of negative externalities. So, even if the energy paradox is not present, the energy-efficiency gap may be. As in the first realm, the theoretical arguments are strong. Empirical evidence is considerable, and in many cases data are likely to be available for additional research. Existing policies appear not to be sufficient from an economic perspective, suggesting that further research is warranted. Indeed, we ascribe high priority to the pursuit of research in this realm.

Third, we ask whether product choices are cost-minimizing in present-value terms, or whether various market failures and/or behavioral phenomena inhibit such cost-minimization. We find that the empirical evidence ranges from strong (split incentives/agency issues and inattention/salience phenomena) to moderate (heuristic decision-making/bounded rationality, systematic risk, and option value) to weak (learning-by-using, loss aversion, myopia, and capital market failures). Importantly, here, as elsewhere in our review, the bulk of previous work has focused on the residential sector and much less attention has been given to the commercial and industrial sectors. Some areas merit priority for future research, such as empirical analysis of split incentives/agency issues in areas where efficiency standards are not present, and much more work can be done in the behavioral realm.

Fourth, we ask whether other unobserved costs may inhibit energy-efficient decisions. We find that the empirical evidence is generally sound, and that data needed for more research are available. We assign a relatively high priority to future research, particularly to aid understanding of consumer demand for product attributes that are correlated with energy efficiency, thereby informing policy and product development decisions.

Three Categories of Potential Explanations of the Gap

Finally, we ask what these findings have to say about the three categories of explanations (reviewed in detail in my 2013 essay at this blog) for the apparent underinvestment in energy-efficient technologies relative to the predictions of some engineering and economic models: (1) market failures, (2) behavioral effects, and (3) modeling flaws. In brief, potential market-failure explanations include information problems, energy market failures, capital market failures, and innovation market failures. Potential behavioral explanations include inattentiveness and salience, myopia and short sightedness, bounded rationality and heuristic decision-making, prospect theory and reference-point phenomena, and systematically biased beliefs. Finally, potential modeling flaws include unobserved or understated costs of adoption; ignored product attributes; heterogeneity in benefits and costs of adoption across potential adopters; use of incorrect discount rates; and uncertainty, irreversibility, and option value.

It turns out that all three categories of explanations are theoretically sound and that limited empirical evidence exists for every category as well, although the empirical research is by no means consistently strong across all of the specific explanations. The validity of each of these explanations—and the degree to which each contributes to the energy-efficiency gap—are relevant for crafting sensible policies, so Gerarden, Newell, and I hope that our new monograph can help inform both future research and policy. Given the many energy-efficiency policies and programs that are already in place, high priority should be given to research that evaluates the effectiveness, cost-effectiveness, and overall economic efficiency of existing energy-efficiency policies, as well as options for their improvement.

When Reasonable Policy Discussions Become Unreasonable Personal Attacks

Recently I was reminded of the controversy that erupted late in 2014 about remarks made by the distinguished health economist, Jonathan Gruber, professor at MIT for two decades. Professor Gruber, one of the country’s leading experts on health policy, had played an important role in the construction of the Obama administration’s Patient Protection and Affordable Care Act, subsequently derided by its political opponents as “Obamacare.”

A brief but intense political controversy and media feeding-frenzy erupted when videos surfaced in which Professor Gruber – largely in a series of academic seminars and conferences – explained how the Act was crafted and marketed in ways that would make it easier to develop political support. For example, he noted that insurance companies were taxed instead of patients, fundamentally the same thing economically, but vastly more palatable politically. He went on to note that this was possible because of “the lack of economic understanding of the American voter.” His key point was that the program’s “lack of transparency is a huge political advantage.” Is that a controversial or even unique observation?

A Truism of Political Economy

Any economist who has worked on the development or analysis of public policy – in areas ranging from health care policy to environmental policy to financial regulation – recognizes the truth of the key insight Gruber was communicating to his audiences. It is inevitably in the interests of the advocates of a policy to make the policy’s benefits transparent and to make its costs vague, even unobservable; just as it is in the interests of the opponents of a policy to make that policy’s benefits obscure and its costs as clear as the light of day.

The specific construction of hundreds of public policies are explained by this truism. In the United States, Corporate Average Fuel Economy Standards (or “CAFE standards”) have been a bipartisan Congressional success, despite the fact that the costs they place on the American public per unit of fuel savings are vastly greater than the costs of a commensurate increase in gasoline taxes. Likewise, when conservative opponents of CO₂ cap-and-trade wanted to stop the House-passed bill in its tracks, they resorted to demonizing it as “cap-and-tax.”

So, the central lesson Professor Gruber was offering is hardly controversial, and its enunciation ought not lead to the terrible attacks that he suffered. He doesn’t need me to defend him, but he was unfairly demonized, simply because people disagreed with him politically regarding the merits of the public policy he had helped develop and support.

Unfortunately, I was reminded of this recently when I found myself subject to attempted demonization, because someone did not agree with a policy I supported. What happened to me is trivial compared with what Professor Gruber has gone through, but it prompts me to write about it today.

Can We Agree to Disagree?

I have written before at this blog about the reasons why I support my university’s decision not to divest its endowment of its fossil-fuel company holdings. I won’t repeat those arguments here, but will note that I have gone out of my way not to draw conclusions or make recommendations about what other universities or other institutions ought to do in this regard, including when I agreed to write an essay on the subject for Yale Environment 360. My analysis and conclusions were not developed in spite of my decades of research, teaching, and outreach on global climate change policy; rather, they were developed because of my years of work in this area.

There are people, some of whom I greatly respect, who have different perspectives on this issue, and have come to very different conclusions than have I. We have essentially agreed to disagree. They haven’t cast aspersions on me, nor I on them. As my writings on this topic have illustrated, there are many facets to the issue, including economics, politics, ethics, and even religion. No one has cornered the market on wisdom.

And What About the Keystone XL Pipeline?

Likewise, on a quite different topic, on January 8, 2015, Coral Davenport wrote a story in the New York Times about the political debates in Washington regarding the proposed Keystone XL pipeline, and stated that “… most energy and policy experts say the battle over Keystone overshadows the importance of the project as an environmental threat or an engine of the economy. The pipeline will have little effect, they say, on climate change, production of the Canadian oil sands, gasoline prices and the overall job market in the United States.” She went on to quote me (accurately) as having said, “The political fight about Keystone is vastly greater than the economic, environmental or energy impact of the pipeline itself. It doesn’t make a big difference in energy prices, employment or climate change either way.” What I said was consistent with the evidence at the time (note, however, that as oil prices fall, the possibility increases that the Canadian oil sands would be uneconomic to develop without the pipeline). Once again, the analysis is not one-dimensional, and reasonable people can respectfully disagree.

When Policy Debates Become Personal Attacks

But these two topics – the Keystone XL pipeline and fossil-fuel divestment – have increasingly become engulfed in highly-charged campaigns and exceptionally heated political debates. As part of this, my integrity was recently attacked, because of my views. A young and – I’m sure – well-intentioned climate activist and journalist, writing in the Huffington Post, implied that my assessment in the New York Times of the Washington political debates regarding Keystone XL and my support for Harvard’s divestment policy, are because “Stavins has done consulting work for Chevron, Exelon, Duke Energy and the Western States Petroleum Association.”

The author of the Huffington Post piece selected those three companies and one trade association from a list of 92 “Outside Activities” that I voluntarily provide as a means of public disclosure. The author chose not to note that the vast majority of my outside engagements are with universities, think tanks, environmental advocacy NGOs, foundations, the U.S. Environmental Protection Agency, other federal agencies and departments, international organizations, and environment ministries around the world (not to mention a set of Major League Baseball teams, but that’s another story altogether).

But what about the four he did choose to highlight? First, I am very proud of my work supported by Chevron and the closely-related Western States Petroleum Association, in which I have carried out a series of analyses studying how to strengthen and improve California’s climate policy under AB-32. That’s right – developing and assessing ways to make the AB-32 cap-and-trade system and the related suite of “complementary policies” more environmentally effective, more cost-effective, and more equitable (I’ve written about this work several times at this blog).

Likewise, my work supported by Duke Energy began a decade ago when I helped the former CEO bring home to his senior management the importance of climate change and the importance of well-designed public policies (in particular, carbon cap-and-trade) to address it. All of my subsequent work supported by Duke Energy likewise has focused on the design of better market-based instruments – cap-and-trade – to reduce CO₂ emissions.

And, finally, what about Exelon? This was interesting and important work I carried out with my friend and colleague, MIT Professor Richard Schmalensee, Dean Emeritus of the Sloan School of Management (I wrote about this work at this blog and at the Huffington Post). In 2011, with support from Exelon, Professor Schmalensee and I analyzed EPA’s proposals for new rules to regulate the interstate transport of sulfur dioxide and nitrogen oxides emitted from electric power generation facilities. You can read in detail about our multi-faceted assessment, but the bottom-line is that we provided strong support for a stringent rule. Our brief summary at the University of Pennsylvania’s RegBlog concludes: “In sum, while imposing incremental costs to achieve reductions in SO2 and NOX emissions, the Transport Rule would produce significant benefits in terms of improved health outcomes, and better environmental amenities and services, which studies estimate significantly outweigh the costs.”

Sadness and Empathy

It is nothing less than absurd – and, frankly, quite sad – that someone would suggest that my views on divestment and my New York Times quote on the politics of Keystone XL were somehow due to my having received previous support for analytical work for an oil company, a trade association, and two electric utilities. This was an unfortunate move to question my credibility and damage my reputation in a misguided attempt to demonize me, rather than engage in reasonable discussion and debate. Unfortunately, most of those who have read the activist/journalist’s original commentary and have possibly repeated his claims to others will not see the essay you have just read.

This is surely nothing compared with what Professor Gruber has gone through, but it has certainly increased my empathy for him, as well as my admiration.

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Personal Attacks: An Even Sadder Epilogue

It’s nearly two months since I wrote the essay above, but a series of recent events prompts me to add this sad epilogue. My family and I have recently been subject to cyber-bullying, harassment, and threats, because of my public stance in support of Harvard’s decision not to divest from its endowment portfolio its holdings of fossil-fuel company stocks.

In particular, the most recent message sent to me said in part: “You may be assured that I will have a lot to say about your vocal public support of Harvard’s fossil fuel investments, … and that I have a particular interest in making sure that [your] financial connections to the fossil fuel industry are made fully public …” This threat to tarnish my reputation by publicizing a supposed conflict of interest is striking for a number of reasons:

In several essays at this blog and elsewhere, I have carefully explained my reasons for supporting Harvard’s decision not to divest;
In several essays at this blog and elsewhere, I have been completely up front about receiving support for (publically available) analytical work I’ve carried out for private-sector companies (and have long provided a list of all outside engagements at my website);
In the essay above, I documented the fundamentally pro-environment, policy-analytic work I had done for the specific companies mentioned; and
The claim that my position regarding Harvard divestment has somehow been influenced by my work with an oil company and an industry trade association defies logic.

The last item on this list – the fundamental illogic of such a claim – merits explanation. People on all sides of the divestment issue (including leaders of the student movement, and including the person who wrote the threat I quoted above) acknowledge that divestment will have no direct financial impacts on the respective companies. Rather, the merit of divestment that is most frequently cited by supporters is its symbolic value. Because divestment has no financial impacts on the fossil-fuel companies, those companies don’t care much about it. They would not care one way or the other what I might have to say on the topic. Hence, even if I did want to curry favor with those companies, that would not lead me (or anyone else) to take a particular position on the divestment issue.

The more important question to ask is whether my research, teaching, and outreach initiatives on climate change economics and policy have been biased by my having carried out consulting assignments for an oil company and trade association (two of a hundred outside engagements over the past several years)? That is, if there really was a conflict of interest, then in an effort to make those companies happy, I would presumably pull my punches regarding recommendations of what does matter to those companies – public policies that will reduce their profits by increasing their costs of doing business and/or by reducing demand for their products. But nothing could be further from the truth!

For a decade or more, my research, teaching, and outreach have focused on more enlightened, stronger, and better climate change policies. I have been outspoken in regard to the pressing need for well-designed carbon-price instruments at the national and sub-national levels, and for the need for better, more effective international climate policies, both under the United Nations Framework Convention on Climate Change and through other venues. This is reflected in my published research, my teaching, and my outreach efforts, including through this blog.

It is ironic, offensive, and sad that anyone would suggest that my support of Harvard’s divestment position is somehow tied to my outside engagements. That suggestion – and the recent threats I have received – defies logic and is contradicted by the record.

Assessing the Outcome of the Lima Climate Talks

In the early morning hours of Sunday, December 14^th, the Twentieth Conference of the Parties (COP-20) of the United Nations Framework Convention on Climate Change (UNFCCC) concluded in Lima, Peru with an agreement among 195 countries, the “Lima Call for Climate Action,” which represents both a classic compromise between the rich and poor countries, and a something of a breakthrough after twenty years of difficult climate negotiations.

Just before two o’clock in the morning, the President of COP-20, Manuel Pulgar Vidal, Peru’s Minister of Environment, gaveled the approval of the text, without dissent. At that moment, the foundation was established for the next major international climate agreement, which – under the auspices of the Durban Platform for Enhanced Action – will be finalized and signed one year from now at COP-21 in Paris, France, for implementation in 2020.

After five days on the ground in Lima, where I participated in a variety of events and met with a diverse set of national negotiating teams, I’ve reviewed the agreed text of the Lima Call for Climate Action (which I abbreviate below as the “Lima decision”), and can now reflect on its gestation, its meaning, and its implications.

The Lima Call for Climate Action

By establishing a new structure in which all countries will state (over the next six months) their contributions to emissions mitigation, this latest climate accord moves the process in a productive direction in which all nations will contribute to the reduction of greenhouse gas emissions.

Working to fulfill the promise made in the 2011 Durban Platform for Enhanced Action to include all parties (countries) under a common legal framework, the Lima decision constitutes a significant departure from the past two decades of international climate policy, which – since the 1995 Berlin Mandate and the 1997 Kyoto Protocol – have featured coverage of only a small subset of countries, namely the so-called Annex I countries (more or less the industrialized nations, as of twenty years ago).

The expanded geographic scope of the Lima Call for Climate Action and thereby the incipient Paris agreement – and the emerging architecture of a pragmatic hybrid combining bottom-up “Intended Nationally Determined Contributions” (INDCs) with top-down elements for reporting and synthesis of contributions by the UNFCCC Secretariat – represents the best promise in many years of a future international climate agreement that is truly meaningful.

Importantly, the Lima decision provides that each country’s INDC shall include a clear statement of emissions mitigation, and may include quantifiable information on reference points (such as base year), time frame of implementation and coverage, assumptions and methodological approaches for estimating and accounting for greenhouse gas emissions, as well as each country’s own assessment of its INDC’s fairness and ambition. These statements of national contributions are to be submitted by the end of March, 2015, although countries that miss that “deadline” can then make their submissions by June.

Compromises, Compromises

Because of the ongoing sharp divide in climate talks between developed and developing countries, the Lima decision was difficult to accomplish and could only be achieved through compromises that had the effect of watering down various aspects of the accord. This suggests that the road to Paris may be difficult for the negotiators.

The substitution of the phrase “may include” for “shall include” in regard to the elements of the INDCs was one of the compromises that was necessary to gain the approval of developing countries. So, the U.S.-favored requirement for the use of transparent elements in INDCs that would facilitate comparisons among countries was dropped.

However, at least one negotiating team with whom I met in Lima maintained that the analyses and comparisons of INDCs that will inevitably be carried out by various NGOs and research organizations (including universities) will provide the needed transparency and therefore the needed encouragement to countries for greater ambition.

A review period for the INDCs, favored by the countries most vulnerable to climate change (sub-Saharan Africa and the small island states), was also scrapped. Instead, a synthesis report will be prepared by the UNFCCC Secretariat by November 1^st, 2015 (based on INDCs submitted by October 1^st).

The Key Roles Played by China and the United States

Throughout the time I was in Lima, it was clear that the joint announcement on November 12^th of national targets by China and the United States (under the future Paris agreement) provided necessary encouragement to negotiations that were continuously threatened by the usual developed-developing world political divide.

The delegates from the vast majority of countries were well aware of the fact that the announced China-USA INDCs move the world from the 14% of global CO₂ emissions covered by nations participating (a subset of the Annex I countries) in the Kyoto Protocol’s current commitment period to a future Paris agreement that now covers more than 50% of global CO₂emissions, with Europe already on board.

Under the decision text of the Lima Call for Climate Action, within the next six months the other industrialized countries will announce their own contributions, and — more importantly – so will the other large, emerging economies – India, Brazil, Korea, South Africa, Mexico, and Indonesia. Coverage of 80% to 90% of global emissions can be anticipated, although major questions remain regarding what can be expected from some key countries, including India, Russia, and Australia.

Broad, Then Deep

In a 1998 book, edited by Bill Nordhaus (Economics and Policy Issues in Climate Change), Dick Schmalensee wrote about “Greenhouse Policy Architectures and Institutions,” and lamented that the Kyoto Protocol exhibited narrow scope (covering only the Annex I countries) but aggressive ambition for that small set of nations. He presciently noted that this was precisely the opposite of what would be a sensible way forward, namely broad participation, even if the initial ambition is less. Based on the 2011 Durban Platform and the 2014 Lima Call for Climate Action, it now appears that with the 2015 Paris Agreement that approach is finally being adopted.

As I predicted in my previous essay at this blog, in which I previewed the COP-20 talks, the Lima decision will surely disappoint some environmental activists. Indeed, there have already been pronouncements of failure of the Lima/Paris talks from some green groups, primarily because the talks have not and will not lead to an immediate decrease in emissions and will not prevent atmospheric temperatures from rising by more than 2 degrees Celsius (3.6 degrees Fahrenheit), which has become an accepted, but essentially unachievable political goal.

As I said in my previous essay, these well-intentioned advocates mistakenly focus on the short-term change in emissions among participating countries (for example, the much-heralded 5.2% cut by the Annex I countries in the Kyoto Protocol’s first commitment period), when it is the long-term change in global emissions that matters.

They ignore the geographic scope of participation, and do not recognize that — given the stock nature of the problem — what is most important is long-term action. Each agreement is no more than one step to be followed by others. And most important now for ultimate success later is a sound foundation, which is what the Lima decision can provide.

Major Challenges Along the Road to Paris

The major sticking points from now until the Paris talks, where it is hoped that the new post-2020 agreement will be signed, are all associated with the divide between rich and poor nations.

The ongoing talks will need to satisfy the interests of both the rich and the poor countries in regard to finance mechanisms, including the realization of the $100 billion commitment that was made in Copenhagen.

Also, looming in the wings is the loss and damage mechanism created in the Warsaw talks last year to help the most vulnerable nations cope with the effects of climate change. Island nations want that mechanism to become another stream of funding from the rich countries, but the rich countries are concerned that the mechanism might lead to some notion of legal liability (and thereby a blank check). The loss and damage concept was reiterated (but not expanded) in the Lima decision.

These and other pending issues mean that the upcoming talks in 2015 in Geneva and Bonn, prior to the December 2015 Paris Conference, will continue to require difficult negotiations across the divide between rich and poor countries.

Difficult indeed. Whereas the agreed decision text from Lima (the “Lima Call for Climate Action”) is less than four pages in length, the Annex (“Elements for a Draft Negotiating Text”) of additional options for the Paris Agreement extends to more than 37 pages!

The Bottom Line

Although it is true that the Lima decision text was watered down in the last 30 hours (as a result of very effective opposition by developing countries), the fact remains that a new way forward has been established in which all countries participate and which therefore holds promise of meaningful global action to address the threat of climate change. So, despite all the acrimony among parties and the 30-hour delay in completing the talks, the negotiations in Lima these past two weeks may turn out to be a key step along the way.