Overriding Consumer Preferences With Energy Regulations

Abstract

This paper examines the economic justification for recent U.S. energy regulations proposed or enacted by the U.S. Department of Energy, the U.S. Department of Transportation, and the U.S. Environmental Protection Agency. The case studies include mileage requirements for motor vehicles and energy-efficiency standards for clothes dryers, room air conditioners, and light bulbs. The main findings are that the standards have a negligible effect on greenhouse gases and the preponderance of the estimated benefits stems from private benefits to consumers, based on the regulators' presumption of consumer irrationality.

Introduction

The efficiency rationale for any government regulation rests on the existence of some type of market failure. The ways markets may fail are quite diverse, ranging from characteristics of the market structure to various kinds of externalities; that is, adverse effects on parties other than the buyer and seller of a product. In the absence of some type of market failure there is no legitimate basis for regulation from the standpoint of enhancing economic efficiency.

This working paper examines a major class of recent government initiatives by the U.S. Department of Energy (DOE), the U.S. Environmental Protection Agency (EPA), and the U.S. Department of Transportation (DOT) pertaining to energy efficiency (as distinct from economic efficiency). The regulations of interest all pertain to consumer products that are durable goods. There may be some kind of market failure with respect to the energy usage of these products, as energy use leads to environmental consequences. However, the existence of an imperfection alone cannot justify all regulations that take the form of government intrusion into the marketplace to override consumer choices. We examine the justification for these energy regulations and show that demonstrable market failures are largely incidental to an assessment of the merits of these regulations. Rather, the preponderance of the assessed benefits is derived from an assumption of irrational consumer choice. The impetus for the new wave of energy- efficiency regulations has little to do with externalities. Instead, the regulations are based on an assumption that government choices better reflect the preferences of consumers and firms than the choices consumers and firms would make themselves. In the absence of these claimed private benefits of the regulation, the costs to society dwarf the estimated benefits.

We begin with a discussion of how one might assess the desirability of energy-efficiency standards. What criteria should be applied to such policies? We advocate the mainstream- economics approach of evaluating the merits of regulations based on their benefits and costs and whether, on balance, the regulations promote social welfare.[1] But framing the issue in these terms is only the starting point; it leaves open the determination of what constitutes a cost or a benefit. As our discussion in this paper indicates, government agencies do not properly assess the benefits from energy-efficiency standards. They assume consumers and, in some cases, firms are incapable of making rational decisions and that regulatory policy should be governed by the myopic objective of energy efficiency to the exclusion of other product attributes. Energy- efficiency standards provide a valuable case study of how agencies can be blinded by parochial interests to assume not only that their mandate trumps all other concerns but also that economic actors outside of the agency are completely incapable of making sound decisions. The assumption that the world outside the agency is irrational is a direct consequence of the agencies’ view that energy efficiency is always the paramount product attribute and that choices made on any other basis must be fundamentally flawed.

The most prominent economic justification for environmental policies is to remedy a market failure due to externalities, which do represent actual potential benefits of energy- efficiency standards. The classic example of an externality is the release of air pollution as a byproduct of production of a marketable good. The air pollution harms human health, but abatement raises the firm’s production cost. If the government clearly establishes a property right for the clean air, then depending on who owns the property right, either polluters would need to purchase the use of the air or the victims of pollution would need to pay polluters to reduce pollution. Either way, as Ronald Coase demonstrated, the social costs of air pollution are internalized into the market decision, resulting in an economically efficient outcome.[2] However, high transaction costs frequently prevent the affected parties from reaching an efficient solution, especially in the case of air pollution in which large populations are exposed to pollution. As a result, abatement is not undertaken since the production decision is made without considering the external harm to human health. In these cases, more direct government intervention (whether through market-based instruments such as a pollution tax or through command-and-control regulations) can achieve the level of air-pollution reduction that increases net benefits to society.

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