How Does the Rebound Effect Influence Optimal Energy Policy
Policymakers and Industry alike are constantly working to increase energy efficiency for a continuum of motivations ranging from maximizing welfare to profit. Utility-maximizing consumers often respond to these improvements in ways that diminish the decrease in energy usage saved by the improvement, a phenomenon labeled the Rebound Effect. Understanding the rebound effect is critical for ensuring the accuracy of energy policy, and even more so when climate change has become a central issue for the national political landscape. In this post we will discuss two extremes for how efficiency innovation can arise, the mechanisms in which consumers respond to energy price reductions, and the macroeconomic components of the rebound effect.
There are two distinct ways that energy improvements are realized: Zero-Cost Breakthroughs (ZCBs) and Policy-Induced Innovation (PII). In a ZCB, these breakthroughs allow manufacturers to increase efficiency “costlessly”. While this may seem an odd phrase since research and development costs are nonzero, we are thinking of economic costs here. Economic costs are defined as costs above the next best alternative. PIIs however result from policy requirements for energy improvement. Since these are government mandated, the efficiency gains may come at a cost (yes, still thinking of economic cost). There is certainly a continuum of reasons for efficiency gains between ZCB and PII however defining the edge cases is useful for identifying the full range of possible outcomes.
The most important reason for understanding the distinction between ZCB and PII for researchers is the differences in effect identification. In ZCB, where the manufacturer is able to make a costless efficiency improvement, other attributes of the product are held the same. Then, improvement can be isolated and the consumer response only to the efficiency improvement can be more easily measured. Distinctly, PII often comes with a bundle of changes to the product such as size, weight or appearance necessitated by the efficiency requirements. Here, we would be better served to measure the overall effect of policy changes, rather than the isolated effect of efficiency improvement.
Efficiency gains often come with price decreases that are passed to consumers. Both the substitution and income effects come into play here to influence consumer response. When price for a particular energy “good” is reduced, consumers substitute towards the more efficient good and away from the inefficient good. For example, Tesla owners may substitute towards driving their Tesla and away from other alternatives like taking an Uber or a bus. Additionally, as a result of the price reduction, consumers now have increased purchasing power and will increase consumption of normal goods (potentially including the more inefficient energy goods). Steve Sorrell, an energy policy expert at the University of Sussex studied three energy saving actions: turning the heat down 1 degree Celsius, replacing car journeys under two miles with walking or cycling and throwing away one third less food. Sorrell calculated that if you did these things and then spent the money you would save in line with your normal spending patterns the rebound effect would be thirty four percent, meaning just sixty six percent of the emissions reduction would actually take place. The benefit is not only limited to the greenhouse gas reduction however, because the consumer now has greater purchasing power and consumer welfare can be improved.
Macroeconomic components of the rebound effect can likewise be split up into price and growth effects. The macroeconomic price effect is realized through both consumer and producer responses that result in a new economy-wide quantity demanded. The macroeconomic growth effect is the idea that improvements in efficiency can spur economic growth through increases in total productivity or reallocation if inputs across sectors of the economy. It can be further broken down into three parts.
The first, sector reallocation, occurs when the sector with improved efficiency of energy-intensive inputs provides a larger relative return to investment leading that sector to grow faster than others. The second channel is that innovations can spill over across sectors. For example, improvements to automotive engines may be used to build more efficient engines for airplanes or lawnmowers. The final channel for spurred economic growth is under considerable debate. Some argue that resources can be freed by ZCB to be spent in new ways that utilize previously idle resources. No-Till Farming is a ZCB that can save farmers 4,160 gallons of fuel for every 1,000 acres converted to continuous No-Till along with an average of 67 hours of labor for each eliminated pass. Fields managed with No-Till also generally have higher water holding capacity leading to additional economic gains to farmers over time. With the saved fuel and labor costs, farms can reinvest into rebuilding the farmstead and purchasing new equipment including tractors or milking machines that can even further improve efficiency.
Existing research does not support claims that the backfire will reverse efficiency gains, with most estimations of the microeconomic portions of the rebound effect between twenty and forty percent with the total effect not being larger than around sixty percent. Rather than focusing on the rebound and backfire alone, it is important to consider the overall welfare gains from increased efficiency. While energy usage may not decrease as much as the efficiency gain alone, consumers are now able to re-allocate their resources to further improve their wellbeing. Rather than a deterrent to energy policy, the rebound effect should be thought of as a positive tally for energy efficiency improvements.
SOURCES:
Gillingham, Rapson and Wagner – Rebound Effect and Energy Policy
USDA – Economics of No-Till Farming