Economic Irrationality

Irrational Incandescence
May 31, 2007 -- By The Economist via Energy Bulletin

Some ways of cutting carbon are cheaper than others. So, at different carbon prices, different sorts of methods of abatement become worthwhile. Vattenfall, a Swedish power utility, has tried to quantify which ones would be worth undertaking at what price (see chart 3).

The result is a testament to economic irrationality. The measures below the horizontal line have a negative abatement cost—in other words, by carrying them out, people and companies could both cut emissions and save money. At a macroeconomic level they would boost, rather than reduce, economic growth.Lighting, for instance, accounts for some 19% of the world's electricity use. A standard incandescent light bulb costs around €1, says Theo van Deursen, chief executive of Philips Lighting, and uses €15-worth of electricity a year. A low-energy one costs €5-6 and uses €3-worth. The payback on investing in a compact fluorescent bulb, therefore, is less than a year. Yet low-energy lighting makes up only 30% of Philips's sales. Mr van Deursen admits to being disappointed. Sales are rising faster in the developing world: there, people pay more attention to electricity bills than they do in the rich world.

Economists trying to explain this apparent irrationality suggest that the savings are too small and the effort involved in change too large. People find their electricity bills too boring to think about; within companies, those responsible for keeping bills down may not have the authority to spend the necessary capital. Another explanation is the agency problem: that the developer who would have to pay higher capital costs up front will not be forking out for the electricity bills. Besides, people buy houses not because they have good insulation but because they have pretty views.

Compared with pursuing greater energy efficiency, the abatement measures into which so much money is now being poured look rather expensive. Carbon capture and storage and wind and solar power, for instance, all have positive, and relatively high, abatement costs.

But the cheapest sources of abatement are difficult for policymakers to get at. Billions of different actors are involved. They cannot be targeted in the way that a few hundred factories can. What is more, a moderate carbon price is not likely to be effective, since people clearly do not care enough about cost.

One policy option is to decouple the utilities' revenues from the amount of electricity they sell. That gives them an incentive to increase the efficiency of power usage rather than to produce and sell extra power. California is already doing this, which is presumably why electricity prices there are among the highest in America, while consumption is relatively low.

Energy-efficiency standards, such as building regulations, are another option. Economists generally prefer to avoid rules that specify what companies can produce and how, because they require governments, rather than markets, to allocate resources, and markets tend to do a better job. But if, as in this case, a public as well as a private good is involved, and the market does not seem to be doing its job properly, there is an argument for governments giving it a nudge.

There are lots of energy-efficiency regulations in place already, and they are being tightened. Incandescent light bulbs are the top target at the moment. Both the European Union and Australia said earlier this year that they are planning to ban them. But the man in the vanguard of this green revolution is Fidel Castro, who started phasing them out two years ago.

~~~~~~~~~~~~~~~ Editorial Notes (Energy Bulletin) ~~~~~~~~~~~~~~~~~~~

Nice piece by The Economist (UK). Another good one from the Economist: The truth about recycling. Conservatives and libertarians in search of an intelligent way to approach environmentalism might have a good role model in the (conservative) Economist...

The Vattenfall website has a big section on climate change.

The chief executive of Vattenfall, Lars Josefsson, was recently profiled: Hero or villain? A carbon critic relies on coal (International Herald Tribune).

Europe seems to be further along than the USA in its sense of urgency about conservation. Der Spiegel had a long series about it: Why Conservation Is the World's Best Energy Source.

UPDATE (June 13)
Two posters at The Oil Drum found source documents for the striking graphic in the article. The graphics in those documents are more readable and more complete than the graphic in the above article.

Marco located a bigger and better version of the figure on page 7 or 8 of Vattenfall’s Global Climate Impact Abatement Map (25-page PDF).

Peaknik located another version of the graphic on page 10 or 11 of Global Mapping of Greenhouse Gas Abatement Opportunities (54-page PDF).

David Jeffery's response to Irrational Incandescence:
Cheap ways to reduce greenhouse emissions
June 28, 2007 -- By David Jeffery, Oikos

An interesting article in The Economist last month took a look at the cost of various options for reducing greenhouse emissions (summarised in the graph above).

Two things are particularly notable:

* There are a number of options that have a negative cost. In other words, not only would they reduce emissions, they’d also save us money. The biggest one is insulation and low-energy lighting is also up there.

* The solutions we hear a lot about – such as wind, solar and carbon capture – are among the most expensive options.

So why are we not voluntarily making decisions that would not only reduce emissions but also save us money?

The Economist identifies a couple of possible reasons, the most compelling to my mind is that the people who make the choices are not the people who pay the costs of those decisions. For example, property developers have to pay for insulation but they won’t get the benefits of lower electricity bills, so their incentive is to go cheap on insulation. If the property is to be rented out, it’s not even the buyer who pay those bills – it’s a tenant.

How to solve this? In theory, awareness of the issue should be enough: if tenants and buyers of new houses (or other buildings) are aware that good insulation can save them substantial amounts of money, they should demand it and be prepared to pay more for it – in the same way they’d be prepared to pay more for a good bathroom or kitchen.

So why isn't this happening? And seeing as it doesn’t seem to be happening, is there a role for government in mandating it in building standards or requiring developers and sellers to at least provide understandable information (eg, energy efficiency ratings)?