In the past couple of days I’ve done some things that have given me some insights into my current research questions – I’ve purchased appliances for our house and I’ve gotten our car’s emissions tested. Both of these situations have implications for policy regarding what are typically viewed as negative externalities. The main question to ask is: do we really need to devote as much public policy attention to “internalizing externalities” as we seem to do? My answer is, probably not.
My appliance shopping illustrates the point nicely. Without loss of generality, let’s concentrate on the decision over the clothes washer. I have always been a huge fan of front-load washers for five main reasons (in declining order of importance): they treat clothes more gently due to the absence of an agitator, they get clothes clean with less water, they are quieter, they use less electricity, and they are sleek and well-designed. In other words, functionality is the foremost priority, but I also care about the washer’s resource use and its design. In this case, I’ve cared even though I’ve never had to pay a direct water bill, but have always had the water bill rolled into the condo assessment. Saving water and energy matters to me, and my appliance choices have reflected that preference, even in instances where I may have to pay more for the more efficient one.
So, not surprisingly, I was looking at the Bosch Axxis washer. Sleek design, good water management, lots of options for cycle type/spin rate/etc. At $999 it is not cheap, about double the price of higher capacity top-load. But the combination of the features that satisfy my five preferences listed above led me to be willing to pay that much for it.
But the sales associate at Abt Electronics suggested that I consider the Fisher-Paykel washer, for a few reasons. First, Fisher-Paykel is making their name selling high-efficiency appliances that are superbly designed and deliver good results with very low water and energy use. They are already famous for their dish drawer, which is a great innovation that allows you to do half loads, and to stack two together to have the profile of a traditional dishwasher but to load and unload like regular drawers. It’s about 30% more expensive than competing dishwashers, but its unique drawer design has attracted a lot of customers, as has its low water and energy use. We are getting one (duh).
Second, even though the Fisher-Paykel washing machine is a top loader, it does not have an agitator. Its center core has rubber flippers that have electronic sensors that estimate the weight of the load. The water comes in through 300 holes in the tub, so it can soak all of the clothes and dissolve the detergent with less water. That also means that you can fill the tub pretty full without overloading the machine, so you can exploit some economies of scale in load size (good for time management and for resource use). The tub rotates back and forth to agitate the load and get cleaning surfactant action without having to rub the clothes together, so it’s gentle on the clothes. The water exits the tub through the middle core at the end of each part of the cycle. You can choose a spin speed, enter the type of fabric, and enter the water temperature.
Sounds pretty cool, right? And believe it or not, it was only $599, $400 less than one of its closest competitors, the Bosch. So not surprisingly, I went with the Fisher-Paykel, because it fared well on all five of my criteria, and did so at a good price relative to the competitors. They are certainly pricing this thing to move, aggressively.
By now you are probably asking, OK Lynne, why should we care that you are a laundry weenie? Both of the washers that I considered are Energy Star certified, and there is currently a $100 rebate on Energy Star-certified clothes washers. This rebate is being funded by the Illinois Department of Commerce and Economic Opportunity, ComEd, and the Midwest Energy Efficiency Alliance. So the net price I pay for the washing machine is $499. Energy Star is a federal government standard for appliance energy efficiency.
I would have bought the thing even without the rebate inducement. Heck, I went into Abt ready to spend almost double, before I knew about the rebate inducement. In other words, for people like me, with the preferences and/or the income to choose energy efficient appliances voluntarily, without any social engineering, the $100 plus the administrative and bureaucratic cost to fund and operate this program is an unnecessary expenditure.
Put another way: for customers like me, the Energy Star certification has some signaling value (it makes it easier to know which appliances are more energy efficient), although I could have gotten the information from the manufacturers’ websites. But the $100+ spent to internalize the externality was unnecessary in my case because I am choosing to “internalize the externality” myself, based on my own preferences and willingness to pay, without any inducement. Where’s the externality? This $100 just feels like redistribution, a transfer of surplus from other taxpayers to me for something I was going to do anyway.
So the policy question is this: why are they paying me to buy something I was going to buy already? If enough people are like me in the sense that they have the combination of preferences and incomes that they would choose energy efficient appliances anyway, why are we spending all of this money to “internalize externalities” that consumers are voluntarily “internalizing” anyway? Or, put differently, is there a meaningful number of consumers for whom the rebate is “Pareto-relevant”? Or are the remaining “externalities” irrelevant because enough of us are choosing to “self-internalize”? And if enough of us are doing so, and companies like Fisher-Paykel are putting products out there at very attractive prices, so what if some lower income folks free ride on our decision to buy energy efficient appliances? Part of the problem is that the standard social engineering perspective is that we should all reduce our energy use to as close to zero as humanly possible, so in some sense the advocates of the social engineering don’t think there is ever “enough” reduction in energy use. That perspective shows no concept of tradeoffs.
Pareto-relevant means that the rebate changes an individual’s decision at the margin from a less energy efficient appliance to a more energy efficient one. The rebate form has a questionnaire on it that asks you to list the primary reason you bought this particular appliance. In my case, I’ll answer it “gentler on clothes”. “Rebate” is one of the choices, as are “energy savings” and “water savings” and “quieter operations” and “like to buy the best”. In theory, these data could enable the sponsors to determine for how many of the purchasers the rebate was Pareto-relevant, although the fact that you can only choose one instead of listing them in rank order limits the value of the data.
Another policy question is this: is there a cheaper way to get us all to self-internalize? This is another way of asking if there isn’t a cheaper way to create property rights, thereby aligning the incentives to use fewer resources with the individual incentive to reduce resource use because it reduces costs. That question leads to the inevitable implication that energy and water prices that consumers pay must be transparent – they have to be allowed to reflect fluctuations in the cost of providing energy and water to consumers. If we had to confront the real costs of energy and water, then we would self-internalize to a large extent out of a desire to control our private energy and water costs.
That claim itself has two important implications. First, in real-world applications it’s difficult to discover the extent to which price transparency would lead enough people to buy energy efficient appliances to reduce overall resource use. This is where a well-placed plug for experimental economics is appropriate. Suppose we design a move from regulated water and electricity prices to market prices. We could construct an experiment that would look at the effect that regulatory change would have on appliance choices and, through that, on energy and water use. That would give us some handle on how many of the “externalities” that rebates such as this one are intended to internalize are actually Pareto-irrelevant, and should therefore be policy-irrelevant.
Second, we don’t each have to be forced to pay full, real-time fluctuating, prices for energy and water (note this is more relevant to energy than water). But the prices we pay currently for energy (and for water) are typically discounted, especially for residential customers, and we cannot choose from a portfolio of contracts that either allow us to insure against price fluctuations or to choose how much of the price fluctuation we are willing to bear. Such pricing choices would give us opportunities and incentives to “self-internalize” these supposed energy use externalities.