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The Trouble with Freeriders

The debate about freeridership in energy efficiency isn’t wrong, but it is wrongheaded.

Fortnightly Magazine - March 2012

low (not high) incentives, relative to a measure’s incremental cost. These are the consumers who most likely would have adopted the energy efficiency on their own. This negative correlation between freeridership and incentives was amply demonstrated in a recent study in Washington. The study surveyed about 350 consumers who had participated in eight conservation programs that offered different levels of incentives. Participants were asked a number of questions on why they took part in these programs. Based on their answers, each respondent was assigned a freeridership score. A comparison of these scores with the incentives received by the respondents showed a strong negative correlation between ridership and incentives. 13

An element of equity does come into play in ratepayer-funded conservation. Any disparity between how benefits and costs are distributed among customers is important; If a customer enjoys the benefits of conservation, one might wonder why the bill for those services should be divvied up and sent to his neighbors, especially if he was willing to pay for them. However, in the context of ratepayer-funded conservation, freeridership is probably less about fairness and more about economic efficiency.

The economic efficiency argument was first formulated systematically in 1992 by Paul Joskow and Donald Marron. 14 In their analysis of data on 16 utility-sponsored conservation programs, the authors identified freeridership as one of the most important issues in determining the costs and valuing the benefits of conservation programs. The particularly remarkable aspect of the study was its characterization of freeridership as a dynamic problem. The problem, they argued, derives from the fact that freeridership isn’t limited to consumers who would have adopted energy-efficiency measures without the utility program, but also involves consumers who are likely to adopt the measures in the future.

From this perspective, a conservation program merely speeds up the adoption of energy-efficiency measures and increases the maximum penetration the measures are likely to achieve. Freeridership, therefore, isn’t merely a question of “ whether some of this year’s participants would have adopted a conservation measure absent the utility’s program, but when they would have adopted the measure.” 15 Thus, if all of the participants would have installed the measure at some point in the future whether the program existed or not, “the static approach significantly overstates the actual savings of the program.” The failure to account for such dynamic diffusion effects, they argue, results in overestimating the savings and underestimating the cost of conservation.

This argument is true, but only partly. Rather, it only applies to programs involving a retrofit—replacing functioning equipment with more efficient equipment. It doesn’t apply to programs that offer incentives for replacement of equipment on burnout, a significant part of today’s portfolios of ratepayer-funded programs. In these cases, if the failed appliance isn’t replaced with an energy efficient one at the time of its replacement, the opportunity to do so will be lost for the course of the equipment’s useful life.

The argument is also one-sided. It places the emphasis on the acceleration component of diffusion and ignores the potentially large effects of conservation programs on shifting the curve.