The Energy Paradox

Despite all these points in favor of economic incentives, a growing body of economic and psychological research, rooted in behavioral findings, suggests that regulatory mandates might also be a good approach to environmental problems, much better than economists have long thought. And as a matter of practicality in the United States, and many other nations, national legislatures have not been willing to pass a comprehensive carbon tax or cap-and-trade system. This has led regulators who care about climate change to use other methods. Most economists think those methods are distinctly second-best. Maybe so, but maybe not.

How could blunt regulations possibly work better than incentives? A starting point is that when consumers buy motor vehicles and appliances, they might not take adequate account of the potential savings, to them, of fuel-efficient vehicles or energy-efficient appliances. This is known as the Energy Paradox 17: Consumers, who are Humans, decline to spend an extra $100 on a more energy-efficient washing machine that could save them much more than that in just a few years. And if consumers neglect the economic benefits—to them—of fuel economy or energy efficiency, then a regulatory mandate could, in principle, generate large economic benefits, far in excess of those produced by the reduction of externalities alone.

Indeed, a great deal of research suggests that consumers pay too little attention to those benefits, and some analyses by government agencies suggest that the savings from fuel efficiency and energy efficiency mandates are both very real and very large. If so, we should add consumer monetary savings to the benefits stemming from reductions in greenhouse gas emissions and emissions of other air pollutants. As a result, the total savings from aggressive fuel-economy and energy-efficiency mandates can dwarf the costs. In principle, it is possible that their net benefits will actually be much higher than those of economic incentives, which will combat externalities but will not deliver consumer savings.

You might expect us to say that if consumers do not take adequate account of potential savings, they should be nudged, not coerced. And indeed, many nations have taken steps in that direction through mandatory labels pointing out the economic savings. Some of these are behaviorally informed and specifically designed to speak to Humans. We applaud those steps (and will have more to say about them). Still, we share the suspicion of many analysts who believe that while these nudges help, they do not adequately correct consumers’ failure to give adequate consideration to economic savings. However, we do not intend to argue that position strongly, much less to settle the matter.18 At the very least, we think it is worth recognizing the possibility that rules and mandates can get consumers big savings—while at the same time protecting the planet. One illustrative example is building codes. If home builders believe (perhaps rightly) that consumers will not pay more for a more energy-efficient home, then they will under-invest in such things as insulation, which is much cheaper to include when a home is being built than later on.

Regulators, please take notice. (And consumers, please consider those savings.)