17 May 2008

You WILL Do This

This article reports a bill in Hawaii that will require homeowners to buy solar water heaters. On the one hand, this sounds like fascism; on the other, it appears to solve a legitimate coordination problem. The Economist recently wrote on barriers to making investments in energy efficiency:
Often, consumers are poorly informed about the savings on offer. Even when they can do the sums, the transaction costs are high: it is a time-consuming chore for someone to identify the best energy-saving equipment, buy it and get it installed. It does not help that the potential savings, although huge when added up across the world, usually amount to only a small share of the budgets of individual firms and households. Despite recent price increases, spending on energy still accounts for a smaller share of the global economy than it did a few decades ago.

For all these reasons, homeowners, as Lord Stern pointed out in his climate-change report, tend to demand exorbitant rates of return on investments in energy efficiency—of around 30%. They generally want new boilers or extra insulation to pay for themselves within two or three years, says Mark Hopkins, of the United Nations Foundation, an NGO. Businesses are not quite so demanding, he says, but they still tend to put greater emphasis on increasing revenues than on cutting costs.

Similar stories crop up in the markets for new homes and offices, appliances and vehicles. Builders are not the ones who end up paying the utility bills, so have little reason to add to the construction costs—and hence the price of a home or office—by incorporating energy-saving features. The makers of appliances and cars also know that not all consumers and drivers will think as carefully about running costs as about the purchase price. By the same token, landlords have scant incentive to invest in energy efficiency on their tenants' behalf. And power companies are usually keen to encourage their customers to consume as much power as possible.
That last paragraph contains the key incentive problems. Builders have no incentive to install better insulation, triple-paned glass, fuel efficient appliances, etc., since they are unlikely to recoup the marginal investment in a higher price. (Homeowners do have an incentive to retrofit their houses -- if they plan to stay in the house for five-plus years.) Apartment building owners have the least incentive to invest in better equipment since tenants realize the benefits of action (or costs of inaction) in their monthly bills.

The article goes on to note that some entrepreneurs are offering to finance and install more-efficient equipment in exchange for sharing the saving from lower energy bills, but those businesses need a lot of up-front capital and patience to persevere for 3-5 years on contracts that carry non-trivial risk.

Bottom Line: It is difficult to encourage people to invest in high-efficiency products that save energy (or water). The current consensus is to force adoption (by outlawing less-efficient equipment) or subsidize adoption (by making equipment free and then charging users for the costs of running those programs). Either solution is second-best but perhaps better than nothing at all.