Energy efficiency standards and innovation

Compared to 1990, major household appliances in the US today are 50–80% more efficient at converting electricity to useful work (Bianco et al 2014). Driven largely by energy efficiency standards, labeling programs (e.g. Energy Star) and state efficiency policies, these end-use efficiency gains are often seen as the cheapest and easiest approach to reducing energy use.

Soon after the US efficiency policy was instated, however, the industry widely objected to these policies because of the higher purchase price of more efficient products. There were two main arguments. First, as stated by the United Auto Workers (UAW) in regard to the proposed vehicle efficiency standards of 1975, the standards would act as a tax on consumers and drive manufacturing jobs overseas. Second, as noted by the AFL-CFO, the higher purchase prices of products would disadvantage low-income individuals. The industry's mantra was that the US consumed, not saved, its way to greatness (Parisi 1979).

Of course, these objections overlooked the fact that greater energy efficiency saves the consumer money over the lifetime (or even discounted lifetime) of the product. In fact, federal efficiency standards in the US are only adopted after demonstrating positive returns to consumers. The US Department of Energy (DOE) uses several factors to determine where to set an efficiency standard, including lifecycle cost, payback period and the macro-economic impacts of standards. Until 2011, the DOE analyses assumed that the manufacturing costs and retail prices of appliances would be fixed in future years (Desroches et al 2013).

Van Buskirk et al (2014) use historical data to show that not only have prices and lifecycle costs declined over time but also that the rate of the decline accelerated following the first efficiency standards. The authors are careful in not claiming that this is a causal relationship between the standards and price declines since several unobserved factors also contribute to the purchase price of appliances. More work is needed to show this link.

This paper adds to the literature on the interaction between prices and efficiency standards. Others have noted that the prices of appliances have decreased in real dollars over time (e.g. Schiellerup 2002, Ellis et al 2007). Dale et al 2009 showed that government cost-benefit analyses of efficiency standards historically overestimated the purchase price of the appliance and suggested that technological innovation, which is not captured in their models, was responsible. Weiss et al (2010) analyzed experience curves of home appliances and showed that learning rates are much faster for wet appliances (washing machines, laundry dryers and dishwashers) than for cold appliance (refrigerators and freezers).

What separates the Van Buskirk et al (2014) paper from previous analyses is the use of longer-term trend data and a more comprehensive investigation of price impacts. An interesting component of the analysis of Van Buskirk et al (2014) is that they show that the price of improving efficiency also decreases over the period following the adoption of efficiency standards.

If efficiency standards are, in fact, responsible for accelerated price effects, a number of interesting implications arise. First, dynamic adjustments to efficiency standards and the incorporation of learning curves into the cost-benefit analyses behind the standards appear to be justified.

Second, Van Buskirk et al (2014) and others suggest that the learning rates differ substantially between individual products (and countries). While product-level learning curves may be well understood for mature products, such as washing machines, refrigerators and microwaves, the fastest growing segment of residential energy use (approximately 25% of current residential energy) is 'other uses,' which include small electronics, heating elements and a number of products without clear historical price trends (DOE 2014). Implementing 'reasonable' learning curves into efficiency standards may prove difficult or impossible in these rapidly evolving markets (Siderius and Meier 2014). However, there may also be untapped opportunities to exploit energy efficiency standards to drive innovation.

Lastly, the Van Buskirk et al (2014) results imply a need for further research into the mechanisms behind the price declines. What determines the relationship between production cost and purchase price in products regulated by federal appliance standards? Why does the dip in purchase price correlate with the first efficiency standard but not with subsequent standards? What determines the rate of price decreases? How do macroeconomic factors and other markets (e.g. home construction) influence the purchase prices of residential products? Finally, how does the market structure (i.e. imperfect versus perfect competition) of the appliance industry affect how manufacturers are setting prices and responding to policy? As discussed by Einav and Levin (2010), the prospect of market power sometimes incentivizes firms to set prices of products below the marginal cost of production—i.e. the sooner a firm can achieve large-scale production, the sooner it will gain a market share. Understanding where the market is in terms of equilibrium and the strategies used by firms to respond to efficiency policies would shed light on how efficiency standards can best drive innovation.