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California's Green Gaffe

Some green-energy policies disregard the value of energy use, risking market distortion and consumer backlash.

Fortnightly Magazine - November 2007

change this, regulators raise utility bills to fund rebates that make the bulbs free to customers.

As before, considering economic value changes the results of a cost-benefit analysis. The added consideration is that efficient appliances sometimes provide lower-quality services, as this example implies. A consumer who won’t spend $5 to save $10 evidently expects at least another $5 in lost value associated with the cost-saving purchase.

Suppose our consumer fears an $8 loss in value from placing the bulb in a lamp where it doesn’t look good. Then, a $5 rebate will get the customer to accept the bulb, because the free bulb plus the energy price savings (another $10) is enough to outweigh the $8 loss in value. A California analysis only would compare the bulb cost to the energy-generation savings, to find a benefit of $2. However, the overlooked $8 loss in consumer value actually would tip the cost-benefit balance over to a net loss financed again by increased utility bills to other customers.

As a final example, consumers might respond to more energy-efficient appliances by using them more, causing what is sometimes called “bounce back.” If bounce-back effects were considered, California’s calculations would record them as a loss because more energy is used without creating any offsetting gain the analysis can recognize. But when incremental costs actually fall (as when less energy is needed to produce the same service), then increased usage of the appliance by consumers is economically justified and creates added value. Properly understood, bounce back makes the case for efficient appliances stronger, not weaker.

Good Analysis Matters

Practically speaking, California has a large inventory of previous cost-benefit studies. A corrected approach might modify some, but leave others yielding the same answers. It’s also possible some analyses have acknowledged consumer value despite the standard practice document’s directions.

Many important policy choices in California—and in other jurisdictions—seem driven by factors other than economics. For example, California’s multi-billion dollar solar roofs initiative was adopted without any cost-benefit analysis. 4 Similarly, the crisis-era legislation that continues to distort California residential electricity prices was a product of politics rather than any economic justification. 5 And common sense may lead policy-makers to turn down harmful program proposals even if the results of a flawed analysis seem to endorse them.

Still, California spends extensively on cost-benefit analysis, and better calculations could matter for policy making. 6

Consider how a flawed California-style cost-benefit analysis would affect some other industries. A ban on new housing would show large benefits due to reductions in land, materials, and labor the home building would have consumed. A ban on new clothing would “save” mountains of fabric.

As such examples illustrate, a genuine economic benefit is created when a consumer buys a product for a price that exceeds its cost of production, and any cost-benefit analysis approach that ignores this value will produce undesirable policy results.

Neither does correcting this problem preclude action on global warming. For example, a carbon tax effectively increases the marginal cost of fossil-fuel-based electricity. However, consumers and society still can benefit even when using