Energy efficiency, climate change policy and prices

Jeff Rubin makes an important point:

The fact that the high-efficiency furnace generates more heat for a given amount of fuel burnt doesn’t necessarily mean I will end up with any fuel savings. As the cost of my heating falls, might it just allow me to set my thermostat higher? If so, my energy savings go right up the chimney.

In the longer term, this point is even stronger. For a given level of prices, more fuel-efficient furnaces encourage larger houses, and more fuel-efficient engines encourage larger cars. The development of more efficient technologies will not necessarily lead to a reduction in the demand for fossil fuels.

This sort of insight is what economists bring to the debate on climate change policy. If you want people to reduce their consumption of fossil fuels, you have to increase their price. More efficient technologies clearly have an important role to play here: they make it easier to adjust to those price increases. But without that price signal, there's little reason to think that encouraging the adoption of energy-efficient technologies will have a significant effect on the demand for fossil fuels.

[Update: I knew I had seen this point before, but I couldn't remember where. But as Tim Worstall reminds us in the comments, this is the Jevons paradox.]

Comments

[Leo Petr]

So, in other words, efficiency increases will either:
1. Reduce energy consumption
2. Increase standard of living
3. A little of both

There is less of an issue in this than the argument above implies. Price signals are of course important, but there are practical limits to consumption. For example, few people are likely to set their thermostat for any higher than 25 degrees Celsius.

[Stephen Gordon]

In the short run, yes. Which is why I made the point about long-run effects. And long-run effects are what are the most important when we're discussing climate change policy.

[asp]

We could legislate zero energy buildings. They would use zero fossil fuels no matter what price those fossil fuels are. We can put a moratorium on building single family homes and instead adjust municipal codes to build walkable neighbourhoods.

As well, there are other ways to ration, other than price. Price might be the most politically viable rationing system, but not the only system. In the case of fossil fuels, we can legislate an every decreasing cap on production. While that would affect the price of the end product, the rationing would not be a result of the price, but the other way around, no?

[Just visiting from macleans]

Perhaps economists have a different definition of standard of living, but this one is consistent with what I thought it to be:

1. Financial health of a population, as measured by per capita income and consumption of goods and services by individuals or households.

So, unless you reduce the purchasing power of a household (and hence their standard of living), or encourage them to increase their savings rate, how does one bring about reduced energy use? This is somewhat along the lines of what Rubin is saying, but let me take it a bit further.

Take tax shifting. Increased consumption tax, reduced income tax. If it's revenue neutral, at the end of the month I still have the same amount of money in the bank or my wallet. So, no short term change.

Now, start really cranking up the consumption tax so that it's in my face everytime I fill up my SUV (and reduce income tax accordingly). Eventually I downsize my vehicle to an energy efficient one, and with the reduced income tax and gas savings, I can now afford an extra winter trip to Costa Rica. Or buy a new energy hogging plasma widescreen tv for the patio.

I understand in general the theory, but am unable to see how it would work. Aren't we just too rich as a country, and don't save enough? Doesn't an increased standard of living through using energy more efficiently suggest we will consume more elsewhere?

[Min]

Jeff Rubin: "The fact that the high-efficiency furnace generates more heat for a given amount of fuel burnt doesn’t necessarily mean I will end up with any fuel savings. As the cost of my heating falls, might it just allow me to set my thermostat higher? If so, my energy savings go right up the chimney.
"In the longer term, this point is even stronger. For a given level of prices, more fuel-efficient furnaces encourage larger houses, and more fuel-efficient engines encourage larger cars. The development of more efficient technologies will not necessarily lead to a reduction in the demand for fossil fuels."

"This sort of insight is what economists bring to the debate on climate change policy."

This is the kind of systemic insight that I welcome in public discourse. I find it ironic that politicians are good at spotting the systemic flaws in their opponents' simple minded proposals, and then they turn around and make their own simple minded proposals. Amusing, but dismaying.

"If you want people to reduce their consumption of fossil fuels, you have to increase their price."

Probably, but that does not follow. Just because an action generates negative feedback does not mean that the negative feedback cancels the action out. Even in the long run.

Also, the emphasis on price ignores the psychology of human motivation. Money is a universal motivator (almost universal), but there are plenty of others. Furthermore, it ignores culture and cultural change. And nothing short of cultural change will enable us to live in energy balance with our environment. And sooner or later we will do so, assuming that we survive. If we just let it happen, the process is likely to be disastrous.

[Rogue]

I agree. The reason that conserving energy is being encouraged is we expect there to be a scarcity sometime in the future. But if the price right now does not reflect any scarcity, any efficiency gains we get from more efficient machines will feel like a license to use more energy.

[Tim Worstall]

Jevon's Paradox.

The important point is "necessarily". Greater efficiency "might" reduce consumption or it "might" leave it static and it "might" even increase it.

Depends.

[reason]

Isn't the important point that individual efforts are useless. If I decrease my demand, then the price falls and someone else increases their demand. You need to reduce the supply or increase the price (which amount to the same thing).

[Patrick]

Energy is usually way to useful to go unused. The economy will reallocate energy saved via efficiency in one area to do work in another. The only way I can see use declining is by creating a situation where efficiencies are not worth reallocating because the next best choice is uneconomical.

[Luis Enrique]

A related argument ... there is a given quantity of fossil fuel under the ground and we want to minimize the quantity extracted and burnt. Divide the world in to two camps, one set of countries who participate in raising fossil fuel prices via taxation or some other means, to reduce consumption (call them cooperators), and one set that does not (call them defectors). What happens to the raw price of fossil fuels (i.e. pre-tax or before whatever artificial price raising measures are used) as the set of cooperators grows? I reckon the price falls, increasing consumption by defectors and increasing the incentive to defect. If the defectors end up burning all the remaining fossil fuel, aren't we just as badly off, climate wise, as if we'd just gone ahead and burnt it all ourselves?

I know this simple story misses a great deal (for instance, variation in the cost of extracting certain fuels - and how price interact with that) but I do think it says something about how difficult it is going to be keeping that fossil fuel where it is, underground and un-burnt.

[Andrew F]

You just need the cooperators to carry a big stick. There are also practical limits to energy consumption, so if the cooperators manage to get a large percentage of population, regardless of the raw price of fuel, the energy consumption of the defectors is still fairly tightly bounded, since the energy price will not go anywhere close to zero.

Keep in mind that the tax on fossil fuels won't be all deadweight loss. The cooperators are getting public goods along with the energy, so the difference in utility is not so large as it might seem.

[Luis Enrique]

Andrew F

yes that's true - if the set of cooperators is large enough, things are OK. I wonder how one could get some idea of the relevant numbers, particularly how prices would change once the cooperators get going, which I'd have thought would be an important determinant of the size of the defector set.

[Min]

@Luis Enrique: The problems of depletion and pollution are related, but not the same. Depletion will solve the pollution problem, at least going forward. ;) Pollution is the more urgent problem. No organism lives in its waste. Fortunately, we have had successes in dealing with pollution. Even Japan has cleaned up rivers. :)

If the developed countries become cooperators, then the defectors will burn fossil fuel in service of development. China and India come to mind. But now even their use of fossil fuel is only a fraction, per capita, of that of the U. S. The main burden of conservation and pollution control right now lies with those who can afford it. Meanwhile, if the cultures of the developed countries change to incorporate sustainability, that will provide a model for developing nations, and increase the possibility for an international political solution.

Every society has defectors. The existence of criminals, even of organized crime, does not mean that we should scrap the law.

[Doc merlin]

Forcibly increasing the price seems a horrible way to deal with stuff. Increasing efficiency in competitive technologies seems to me would be better.

[Doc merlin]

"Every society has defectors. The existence of criminals, even of organized crime, does not mean that we should scrap the law."

Really this depends on how prevalent it is. The NIE folks would argue that if the vast majority don't follow the law then it de-facto isn't a law, its just an extra transaction cost imposed on the system.

[Andrew F]

Merlin, did you read this thread, or just miss its point entirely?

[Alex Plante]

In practice you become more energy-efficient by substituting capital for energy, so the price ratio of capital to energy is a very important motivator. Any serious government program to encourage energy efficiency should combine higher energy prices (for example a carbon tax) with low-interest loans for investing in energy efficiency (such as home insulation loan subsidies or guarantees).

[Luis Enrique]

How about a policy goal of ensuring the cost of renewable energy is always below the pre-tax cost of fossil fuel? So countries will not be tempted to defect to fossil fuels in order to enjoy cheaper energy. This would entail that cooperators use revenues from taxing fossil fuels to subsidize renewable energy infrastructure and operating costs supplied to defectors. Hopefully technological progress will help.

[Andrew F]

Any revenues the defectors forgo by not taxing fossil fuels is revenue they have to raise from the rest of the economy. Thus, defecting is not such a no-brainer.

[Doc merlin]

I didn't miss the point, Andrew, I just disagree with you.

"Any revenues the defectors forgo by not taxing fossil fuels is revenue they have to raise from the rest of the economy"

Or they just cut or spin-off public services, which is the rout I favor. In the US for example right now we are seeing more and more people move to low-services, low-tax states from high-services, high-tax states because that is where the opportunities are.

[Doc merlin]

"This would entail that cooperators use revenues from taxing fossil fuels to subsidize renewable energy infrastructure and operating costs supplied to defectors"

This itself suffers from the coordination problem and the problem that consumers and markets generally know what is better for themselves than regulators do. The state using its tax revenues to fund "renewable projects" tends to cause absurd market distortions. For example here in texas, in the west, wholesale electricity prices often dip negative, because the subsidies paid to wind farmers means that its better to keep producing even when the market price drops below zero. In general subsidizing operating costs is a terrible idea, and causes really bad market distortions. Funding technology is a better rout to go if you must use public funds.

[Patrick]

Doc merlin: Keep in mind that this is a Canadian site. In Canada the population is so sparse and the country so huge that it's basically never economical for large national infrastructure to be left to the private sector. Either the government has to do it, or private interests need a monopoly, or the government does it and hands it over to a private monopoly. Just look at our telecoms and rail systems. Competition is impossible; who's going to build a redundant telecoms network (for example) to service 30 million people spread in a thin strip across thousands and thousands of miles. So if we want to rebuild the energy infrastructure - and remember it's pretty damn cold here for 6-8 months a year so we use a lot of energy - then it's not unreasonable to propose that the Gov't will necessarily have a hand in it.

[Andrew F]

merlin, no offense, but your comment that price adjustments are a bad way to reduce energy consumption, and that it could be better accomplished through increases in energy efficiency contradicts the thesis of this post. You didn't provide any support for your argument, or a critique of the original thesis, and this gave me the impression you did not read or understand it.

"Or they just cut or spin-off public services"

That is a separate policy decision, and you're conflating the two (size of government, how it is funded). Even low-tax states still have taxes and government services, even to enforce the libertarian's basic government services such as defense and enforcement of property rights.

"Funding technology is a better rout to go if you must use public funds."

The argument here is that this won't work either. You need to raise the relative price of fossil fuels, possibly through taxation. That revenue can be returned by cutting other, less efficient taxes.

Patrick: I'm not convinced that the government needs to have any greater role that creating the right incentive environment. Essentially, a sufficient tax on fossil fuels ought to do the trick, without the mess of massive subsidies, pork barreling, and inefficient allocation of resources through government planning.

[Min]

Moi: "Every society has defectors. The existence of criminals, even of organized crime, does not mean that we should scrap the law."

DocMerlin: "Really this depends on how prevalent it is. The NIE folks would argue that if the vast majority don't follow the law then it de-facto isn't a law, its just an extra transaction cost imposed on the system."

Liquor prohibition in the U. S. is a case in point. OTOH, there are laws against speeding. Even though they are broken right and left, they are enforced to some degree, and remain on the books.

[Luis Enrique]

Andew F, that's a good point, I hadn't thought of that. I suppose the net incentive is quite hard to figure out - after all, if your economy benefits from access to cheap fuel, you can tax the resultant output increase. Anyway, all I was trying to do was shed some light on how difficult keeping those fossil fuels under ground is going to be, when more success in that direction means cheaper prices.

[Doc merlin]

Here goes, Andrew. Price increases through taxation do two things,

1. Increases competitive benefit in the good being taxes by competing governments and localities.

This is especially visible in the US where a large number of cities are nearby each other, and its very easy to drive oneself, around for example in the DFW area, in Texas. Its better to tax stuff that is harder to move, for example housing or income. And even better to tax things that are almost impossible to move such as natural resource extraction.

By instead of taxing the extraction, localities tax the products of the extraction, they mostly harm their own revenue in the long term in favor of short term revenue gains. That has been happening here in the US over the last decade as people move from high-tax, high-services states to low-tax, low-services states.

2. Increases incentive to cheat.

This isn't very strong if the taxes are small, but rises quickly as the taxes rise. If you concentrate taxes on fossil fuels which are a small percent of someone's budget, you have to have relatively high % taxes on the fuels to make up for revenue elsewhere. This makes cheating much more profitable.

[asp]

Patrick "it's pretty damn cold here for 6-8 months a year so we use a lot of energy"

Waste a lot of energy you mean. I take it you are not aware of the fact that passive solar energy can provide all the heat we need in our buildings, even this far north. Not in the far far north, but certainly for areas where most of us live.

[Stephen Gordon]

And yet people still use fossil fuels to heat their houses. Can you think of a way to persuade homeowners to do otherwise so long as the prices of fossil fuels are at their current levels?

[asp]

Building codes.

[Doc merlin]

@Gordon, what do you mean by persuade?
If you use force of law you are effectively killing people whenever there is a blackout caused by a winter storm.

[Patrick]

asp: Passive solar? What about the existing stock of houses and buildings?

I think there is a network effect similar to what Nick talks about with medium of exchange. To a large degree I use it because everyone else uses it. Same with fossil fuels. I use it because that's what my furnace uses, and the furnace was there when I bought the house, and a guy to repair the furnace is just a phone call away, and if I want to replace the furnace the phone book is full of companies ready to sell me a furnace. We all know it works pretty well and we'd rather not risk the pipes freezing in December when it hits -46C (which it did here in Edmonton this December!)

With the nifty 'green' alternatives technologies, I'd probably be only one of a few people using it. There isn't an army of people who sell the stuff, and who know how to install and fix it. Even for passive solar (and I have my doubts that in Edmonton in December when it's -35 that the sun delivers enough energy to keep the house warm through the night, but I'll grant your claim for the sake of argument), what do I do if the kids kick a soccer ball through one of the super fancy high R-value coated windows imported from heaven-knows-where? Wait 6 weeks for a replacement to be shipped to me?

[asp]

Patrick: Existing Stock of buildings?

Same answer, municipal codes. Buildings built 100 years ago currently have to be updated to modern fire and heating codes. We can include retrofitting buildings to zero energy standards through similar codes.

I agree with you about the network effects being the reason why people haven't already made the switch, even though it will save them money in the long run. Which also indicates that raising the price of fossil fuels will not result in everyone converting their homes to passive solar. They will just complain and fork out the extra cash. Which is where the codes come in, forcing people to do what's best for them financially and for the planet environmentally. Pricing alone won't do the trick, or it already would have.

Passive solar is a bit of a misnomer, as it does not require direct sunlight. North facing cold climate low-e windows take in more energy during a winter day than they lose at night. At least in most Canadian cities. I haven't seen the data for Edmonton, but Edmonton is an anomaly, only a small percentage of Canadians live that far north. I lived in Winnipeg when I first researched this, and zero energy buildings are doable there.

PS: Your kids play soccer when its -35 out?

PPS: If everyone used cold climate low-e windows due to building codes, they would be in stock locally.

[Solar Energy for Government Institutions]

I understand there will still be some demand for fossil fuels because they're so readily available, but you can't just jack up the prices on fossil fuels at the present without throwing some people below the poverty line. Millions of people can't afford to convert their homes into zero energy homes. On the other hand, there is progress towards more sustainable buildings. Over here, a company called Hudson Valley Clean Energy recently built the first zero energy building in NY state.

[Climate Change]

They would use zero fossil fuels no matter what price those fossil fuels are....
http://www.facebook.com/pages/Viva-Magazine-Your-Premium-Womens-Natural-Health-Magazine/262734921452?ref=ts

[Just visiting from macleans]

O/T but your other comment strings are closed.

I'd be interested in reading a blog on your views about Can West Foundation's recent report as highlighted in this news story:

Butt out of oilsands, Canada West Foundation tells easterners

Negative talk about the environment threatens economic well-being of all Canadians, new report declares

The Canada West report also acts as a counterpunch to a controversial report released last fall by the Pembina Institute and the David Suzuki Foundation,

http://www.vancouversun.com/business/Butt+oilsands+Canada+West+Foundation+tells+easterners/2494147/story.html

Economics, politics, or both?