Friday, November 16, 2007

Banning Incandescent Bulbs: What are the Economics?

We have all heard the mantra about the virtues of replacing tungsten (incandescent) lights with compact fluorescent lights (CFLs). Here is a typical, effusive projection:

CFLs are four times more efficient than standard, incandescent bulbs and last nine to thirteen times as long. If everyone bought just one CFL and replaced their old standard bulb, America would save $8 billion in energy costs, prevent the burning of 30 million pounds of coal, and save greenhouse gas emissions equal to two million cars. Convert all the bulbs and the savings would be in the tens of billions of dollars.

Government programs like Energy Star make the same claim:

ENERGY STAR estimates that if efficient lighting were used throughout the country, the nation's annual demand for electricity would be cut by more than 10%. This would save ratepayers nearly $17 billion in utility bills.

Sounds pretty good, but should Oregon and Washington ban incandescent lighting (as they are reportedly planning to do) ? The short answer is, "not necessarily". In fact, they make little sense in a cool climate, either from an energy conservation, environmental or consumer cost standpoint.

The Forgotten Physics

An incandescent bulb does, indeed, use about four times the energy to produce roughly equivalent illumination of a CFL. But contrary to the simplistic logic on the CFL packaging, that energy is not "wasted". The theory of physics tells us that energy is conserved; it does not simply disappear. Indeed, essentially all of the extra energy that is used by an incandescent bulb is dissipated as infrared radiation or convection heat. In other words, the incandescent light bulb is heating--as well as lighting-- the room.

Whether this heating effect is a "waste" or not depends upon the climate and heating conditions. If the house is heated, by a gas or electric furnace, the excess heat produced by the light bulb reduces the net demand on these heating systems. This is called the Heat Replacement Effect.

In a home heated and lit by electricity, the waste heat losses of energy at the light bulb are offset nearly exactly by the reduced demands on the heating system. In such a setting, there is virtually no effect on either the cost of electricity to the consumer, or the amount of greenhouse gasses emitted in the production of the electricity used. If the home is heated by gas, it is possible for there to be energy, cost and GHG differences.

For example, if electricity is produced by hydroelectric power, using CFLs will increase GHG emissions as the heat of the bulbs is replaced by increased fossil fuel home heat. If electricity is produced in fossil fuel plants, on the other hand, decreasing the electric load and increasing use of a gas furnace will reduce energy, cost and GHGs slightly due to the relative efficiencies of electric power plants and home furnaces.

But in general, the net benefits of the CFL will be much smaller than the gross effect advertised on its packaging. A 2004 British study concluded that the net energy savings were only about 14 percent of the gross savings. A previous study had found essentially no net energy savings (actually, slightly negative savings) in the UK context. So it is clear that there are no net savings under every circumstance.

The Cost of Bulbs

The discussion above addressed only the on-going costs of running bulbs or CFLs. What about the costs of the bulbs? it is claimed that one CFL lasts 10 times longer than a regular bulb. So a reasonable cost comparison is between the cost of 10 incandescent bulbs and one CFL, bought at the same time. The unsubsidized cost of a CFL is about twice the cost of ten incandescent bulbs. For 60-watt equivalent bulbs, this Excess CFL Cost. is about three to five dollars.

It will make economic sense to replace regular bulbs with CFLs only if the future stream of cost savings (net of the Heat Replacement Effect) is greater than the Excess CFL Cost. It is easy to determine this balance. If the CFL saves 70 percent in energy costs over the regular bulbs, but none of that savings remains after considering Heat Replacement, the net energy savings is zero. Each one percent net savings (as a proportion of gross savings) yields a saving of 63 cents (over the 10,000 hour bulb life at 15 cents per kilowatt hour).

The Bottom Line

A call for universal replacement of regular bulbs by CFLs makes no sense; the viability of the replacement depends on many conditions. Yet, even university scientists make misleading statements in this regard, in their enthusiasm to be "green":

Any time you can substitute a more efficient light source for an incandescent bulb - DO it!

For those of us in cool climates, it may make little financial sense to incur extra bulb costs of three to five dollars to save a few cents. Consideration of GHG emissions issues may push this logic slightly one way or the other, depending upon the nature of the electricity and heating sources. Also, the convenience of not having to change bulbs as often has value as well, in favor of CFLs. But CFLs contain mercury, and pose a greater recycling burden and environmental risk than regular bulbs.

On balance, in cool climates where buildings are heated during low-light seasons of the year, it is not at all obvious that a blanket policy of banning incandescent bulbs makes either economic or environmental sense. They may make sense in regions where additional air conditioning load would be required to offset the incandescent bulbs' heat, but those of us in the coastal northwest should think twice.

Tuesday, November 13, 2007

The Hazards of the Rush to be Green

The public and policy makers are responding to the daily drumbeat of events reported as consequences of global warming. Every especially-warm day, picture of a melting glacier, drought report, etc. adds to the enthusiasm to contain greenhouse gas (GHG) emissions, especially carbon dioxide emissions. The loudest call is for regulation of offending activities and subsidy of non-offending activity.

From an economist's perspective, this thrust is a virtual recipe for failure. It is highly likely that, not only will we not meet goals of reduced GHG emission, but we will in the process of trying, actually make GHG emissions worse than they otherwise would have been.

How can this be? Read on.

The Political Economy of Regulations

Regulation is based on the notion of "market failures", i.e., that the private market mishandles certain resource allocation activity, requiring government to intervene manually and properly redirect resource allocation. In reality, of course, the failure is not of private markets, but rather the failure of government to support even the existence of certain markets.

The economy needs government to provide the supporting legal framework in order for private markets to function. Government has neglected to support markets in air, water, noise and most other resources that constitute the natural environment. Indeed, the Environmental Protection Act actually forbids consideration of benefits versus cost in environmental analyses such as environmental impact studies (EIS). In so doing, the Environmental Protection Act effectively denies the relevance of markets. Again, not a market failure but a governmental failure.

Viewed from this perspective, calling in government to act in lieu of private markets is a bit like asking the guy who was supposed to build the safety nets to run the circus high-wire act. Without any market values or benefits and costs to balance, regulation in the environmental arena can only be arbitrary and capricious. Obviously, this is the perfect setup for a regulation to, in the end, do more harm than good.

Subsidies: The Three-Card Monty of Environmental Policy

The other, general approach to steering the economy to a green future is the subsidy. Hybrid vehicle purchases enjoy tax subsidies, as do solar panel installations, biofuel manufacturing, wind power farms, compact fluorescent light bulbs, etc. Like the sidewalk con of Three-Card Monty, these policies create the illusion that some costs disappear when, in fact, they do not.

Subsidizing a product that would otherwise not be deemed cost-effective by the marketplace risks making the economy less efficient--not only in productivity terms, but also in GHG accounting terms. A solar panel based on solid crystalline silicon cells, for example, likely uses more energy to manufacture, transport, install and operate than it will ever save over its lifetime. Subsidizing such a product and, thereby increasing its use, therefore actually increases, rather than decreases, the amount of conventional energy used in the economy. If conventional energy sources emit GHGs (which they do), then GHG emissions go up, rather than down, through the effect of such subsidies.

Proponents will argue that public subsidies are needed temporarily in order to transform the market and increase penetration of the product. In other words, market participants are too stupid to recognize a good thing without prescient government lighting the way. In fact, of course, private markets make huge investments and take huge risks on unproven technologies every day. The cell phone, Apple computers, Microsoft software,iPods, medicines, the video recorder, jet skis, the automobile, the skyscraper, and a million other products arose primarily from risk-taking capital sources. The notion that there is a silver-bullet energy technology out there that is languishing because of lack of risk-taking capitalists is simply foolish.

Subsidies, by their very nature, bias the economy toward the production of goods that waste resources at the expense of the production of goods that use them more sparingly.

Cap and Trade, Carbon Offsets and other Quasi-Market Schemes

The green frenzy is not without its attempts to mimic real markets through trading schemes. So-called cap-and-trade schemes cap the carbon emissions of a group of producers. As long as some producers caps are not binding, they can sell their excess rights to emit CO2 to another producer whose cap is binding its behavior.

There is, indeed, a market created in cap-and-trade schemes. However, the caps are arbitrary regulatory constructs, the stringency of which is determined in a political economic context. Most cap-and-trade schemes have loose caps that reflect the relative political influence of the capped entities.

Carbon offsets are another method intended to stimulate carbon-sparing activities, such as planting carbon-sequestering trees. Al Gore and Land Rover users can then obtain absolution for their carbon emitting activities by buying carbon offsets. Unfortunately, it is virtually impossible to determine the validity of the carbon-offset arithmetic, or even whether the firm selling the carbon offsets is doing anything different than it would have done in absence of the offset program. Would the tree farmer have planted the trees anyway? Would the landfill have controlled its GHG emissions anyway?

The Market is Working Where it is Allowed to Do So

As long as an input to a production process costs money, businesses have an incentive to be sparing in its use. Indeed, the energy-intensity of the US economy (BTU per dollar of GDP) has been declining steadily for as long as we have data available. Higher energy prices may accelerate this trend, but only if the energy-sparing technologies available to the firm are, themselves, not energy intensive. If they are, then there may be no cost advantage to adopting the new technology.

Ironically, the best way to move quickly toward energy-saving technologies is for a firm, individual or country to be wealthy enough that they can afford to abandon still-useful old technologies in favor of the new. If GHG policies have the effect of impairing personal or corporate wealth, therefore, the turnover of technology wil slow. Those who say that we are just going to have to live more simply, etc., forget this important fact.

Recent trends in energy consumption confirm this notion. Those who embraced the Kyoto Protocols in 1997 such as European Union members, have energy use that is growing more rapidly than US energy use on a per capita basis. While Europe was imposing regulatory constraints on its industry and subsidizing massive solar panel farms (especially in Germany), the US was turning over its capital stock.

Maybe that is why a recent article in Nature declared Kyoto a failure:

The Kyoto Protocol is a symbolically important expression of governments' concern about climate change. But as an instrument for achieving emissions reductions, it has failed1. It has produced no demonstrable reductions in emissions or even in anticipated emissions growth.

In a future post, I will discuss some things that actually might be worth doing.

Friday, July 6, 2007

The Health Care Crisis: Who is to Blame and How to Fix It

The accepted wisdom today is that the private marketplace cannot be relied upon to provide health care. At the heart of most critques of our existing system is the belief that the problem lies with the private market and its greedy health insurers, drug companies and providers.

Senator Ted Kennedy (D-Massachusetts) has been an opponent of every market-oriented reform, despite the fact that the track record of his preferred, government-centric policies has been so poor. Medicare costs, for example, have evolved to be four times the 1965 estimates. Presidential aspirant Congressman Dennis Kucinich (D-Ohio) goes further, asserting baldly that profit making enterprise have no place in the health care system. Finally, the subtext of Michael Moore's muckumentary "Sicko" is that the current system is heartless, cruel and ineffective.

In reality, the problem with the US health care system is that there is too little, rather than too much, private marketplace involvement. This situation, in turn, can be traced to the clumsy interventions by government over the past sixty years. These interventions have marginalized the role of the consumer in the health care market. In fact, the role of the consumer has been so marginalized that it bears little resemblence to the paradigm of the private market in economics. In that paradigm, the consumer, having a personal stake in the outcome, exercises discipline over the sellers of services. Without this discipline, the price and quality of service is indeterminate.

The Clumsy Hand of Government

The first government intervention that hastened the exit of consumer sovereignty occurred as a side effect of other economic interventions in World War II. Specifically, price and wage controls handicapped firms' ability to compete for labor. Firms found a loophole in these controls. The regulators had neglected to include the value of labor benefits, such as insurance, in the regulated wage. Moreover, the Internal Revenue Service had neglected to include the value of such benefits in the definition of taxable income.

Firms began offering health insurance as a workaround to wage controls. By the time that the IRS woke up to what was happening, employer provision of this benefit was widespread and the inadvertent exemption from taxation was memorialized in law. The effect on consumer behavior was profound. The consumer no longer perceived the cost of health insurance directly as a personal cost. The illusion was created that health insurance was a cost to the employer, not the worker. And because it enjoyed special tax treatment, the package of compensation was tilted away from wages toward health insurance benefits.

The second government intervention was to compel, over the years, ever-greater comprehensiveness of the coverage offered by employers. The result was that coverage was expanded to procedures that have little actuarial justification for being insured. Instead of being a mechanism for protecting the consumer against financial and physical catastrophe (like fire insurance, by analogy), health insurance also became a payment mechanism for routine services. By analogy, the fire insurance policy was extended to insuring for the cost of common home repairs and maintenance.

The Loss of Consumer Discipline

The separation of the consumer from the purchase of health services was now nearly complete. The price of service was now of little interest to the consumer who enjoyed the price illusion of insurance coverage. Without the consumer to restrain them, provider costs grew more rapidly. This lead directly to the death spiral of private market health care: consumer indifference led to higher provider costs, which led to higher insurance premium until, finally, employers could not justify providing insurance.

The uninsured and elderly now faced health care costs that had been ballooned by decades of insured consumers' indifference to price. Undaunted by its own culpability for this state of affairs, government vainly sought for more governmental solutions: Medicare, Medicaid, and subsidies for those whom they (government) had put in this pickle in the first place.

Fixing It

What should be done? There are several, simple elements to restoring sanity in the health care system. All, in one way or another, re-insert the consumer into the marketplace:

1. Eliminate the employer as the provider of health insurance. The illusion continues today that, somehow, emplyer-provided health insurance is costless to the worker. The employer could be removed from the process by removing employer-coverage mandates where they exist and eliminating the special tax treatment of employer-provided insurance.

2. Mandate the consumer to acquire a standard, catastrophic care policy. Insurers would compete to provide catastrophic policies based on price and features, with risk rating differentiated only by sex and age, not by pre-existing condition. Consumers be offered favored tax treatment for policy premium expenses for catastrophic plans only. Poor consumers would be offered premium assistance for the basic policy.

3. Encourage the consumer to husband funds for non-catastrophic costs of care. The existing Health Savings Account (HSA) could be the basis for this encouragement.

Adoption of these policies would enhance price competition in insurance and in health care provision. Unlike most other proposals, it reduces, rather than increases, government's involvedment in the marketpalce. Government's role would be limited to defining the method for ensuring that consumers obtained the basic policy, and for devising the assistance scheme for the poor. Government, ever the clumsy mischief maker, will be tempted to compel a definition of the basic policy that re-introduces the problems of comprehensive coverage. To pander to some constituencies, politicians will press to broaden uselessly the definition of who obtains premium assistance. These tendencies, too can be contained:

1. The funds for providing premium assistance to the poor could be raised from an pro-rata excise tax on the insurance plan premiums. This would give consumers a stake in establishing reasonable limitations on the amount of and eligibility for assistance.

2. Politicians' temptation to morph the catastrophic plan into a comprehensive plan by limiting the amount and the growth rate of the policy premium qualifying for tax favored treatment. This, too, would give consumers a stake in having access to affordable plans.

Not a Radical Proposal

Some of the basic features of this proposal are already in place in Switzerland. The State of Massachusetts passed (under former Republican governor and current presidential candidate, Mitt Romney) a related, though flawed proposal. Finally, here in Oregon, the legislature passed Senate Bill 329, The Healthy Oregon Act. It is scheduled to convene an expert panel to determine how to best provide universal access to insurance. Oregon's track record of micro-management of the health care sector does not bode well, but it is conceivable that a market-oriented proposal like that offered here could emerge.

For more detail on my proposal, you can look on the Cascade Policy Institute website.