NOTE: This paper is an updated and revised version of an earlier paper.
“Is There an Energy Efficiency Gap?” is the title of a recent article by Hunt Allcott and Michael Greenstone (2012a) published in the Journal of Economic Perspectives and posted in revised form at the Social Science Research Network (Allcott and Greenstone 2012b).
In their paper, Allcott and Greenstone examine energy efficiency policies and specifically “whether there are investment inefficiencies that a policy would correct.” They conclude that “a reliance on observational studies of variable credibility and the possibility of unobserved costs and benefits of energy efficiency make it difficult to assess the magnitude of the Energy Efficiency Gap definitively. Nevertheless, the available evidence from empirical analyses of weatherization, demand-side management programs, automobile and appliance markets, the ‘landlord–tenant’ agency problem, and information elicitation suggests that while investment inefficiencies do appear in various settings, the actual magnitude of the Energy Efficiency Gap is small relative to the assessments from engineering analyses.”
In this paper, we review their evidence in each of these six areas and find that while the authors have some useful points to make, in general they interpret available data in ways that best support their points, downplaying other important findings in the various articles they cite. For example, in much of the research they cite, they emphasize results using the highest discount rates analyzed in a paper. When the data are examined more broadly, their argument that “the Energy Efficiency Gap is small” does not stand up to scrutiny.
Allcott and Greenstone end with a policy discussion raising objections to the use of incentives and standards to address externalities in otherwise perfectly functioning markets. However, perfect markets are not the environment in which energy efficiency policies are proposed, and externalities are only one of the rationales for policy intervention. As they acknowledge, energy efficiency policies such as standards can be very cost-effective when there are investment inefficiencies.