Environmental Protection Agency

Energy Regulators Think You're Crazy

A new study uncovers what regulators really think of American consumers.

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Federal regulators evidently believe that Americans are irrationally choosing to spend hundreds of billions more on energy than they should. Consequently, benevolent bureaucrats have imposed regulations to guide hapless consumers toward making the proper energy saving choices when it comes to purchasing cars, air conditioners, clothes dryers, refrigerators, and light bulbs. A new study finds that the regulators are, in fact, the ones being irrational.

Regulations have traditionally been justified on the grounds that they are fixing a market failure. The case of pollution in which producers impose costs on downwind or downstream people is the classic case. As economics Nobelist Ronald Coase explained [PDF] years ago, allocating strong property rights enables markets to internalize the costs and produce economically efficient results. Ideally then, if homeowners near a factory have a property right to clean air, the factory owners can offer to compensate them for dirty air or the citizens can force the factory to clean up its emissions.

However, it could cost too much for thousands of affected people breathing bad air to assert individually their rights. In other words, the transactions costs are too for high residents to bother trying to enforce their property rights and so the polluters can keep on pumping out smoke without paying for the damage it causes. This would be a genuine case of market failure and provide a rationale for government to step in with pollution taxes or command-and-control regulations to cut air pollution in such a way as to increase the net benefits to society. 

In recent years, the Department of Energy (DOE), National Highway Traffic Safety Administration (NHTSA), and the Environmental Protection Agency (EPA) have been imposing energy efficiency regulations of various sorts on Americans. In a new working paper, "Overriding Consumer Preferences with Energy Regulations," Brookings Insitution economist Ted Gayer and Vanderbilt University economist Kip Viscusi look for the market failures that DOE and EPA regulations are supposedly addressing and do not find them. Instead, they find blinkered agencies ignoring important aspects of products that consumers value in their single-minded pursuit of energy efficiency. 

Instead of seeking to ameliorate market failures, the agencies largely justify the costs of their energy conservation regulations by asserting that Americans are irrational. Specifically, consumers are supposedly incurring huge welfare losses because they myopically undervalue future energy costs when they purchase various consumer durables, e.g., cars, clothes dryers, refrigerators, air conditioners, and the like. This means that rational and benevolent regulators know better and must force Americans to change their choices for their own goods. For example, the Obama Administration recently proposed to set corporate average fuel economy (CAFE) standards for cars at 54 miles per gallon by 2025.

To justify these new fuel economy standards, the EPA and DOE's National Highway Transportation Safety Agency Administration recently performed benefit-cost analyses that came to very similar estimates. Since there's not much difference, let's just look at how Gayer and Viscusi deconstructed the EPA analysis. The EPA estimates that the total costs of its fuel economy regulations at $192 billion and its benefits at $613 billion. You might think that the sort of benefits would chiefly concern the EPA involve internalizing the costs of externalities like global temperature increases as the result of greenhouse gas emissions and health benefits from abated air pollution. You would be wrong.

As Gayer and Viscusi note, the EPA estimates that those climate change and health benefits actually amount to $46 billion and $8 billion respectively, about 9 percent of the total estimated benefits. However, the EPA's estimate of the climate change benefits from its regulations include the benefits to other nations of reduced U.S. greenhouse gas emissions. "To the best of our knowledge, this is the first situation in which the benefits to other countries other than the United States have been included in a regulatory impact analysis," observe the researchers. Counting only domestic climate change benefits from the CAFE regulations reduces the benefits from $46 billion to a range of $3 to $11 billion, thus accounting for only 0.6 to 2 percent of total estimated benefits. "The estimated costs of the regulation are 18 to 60 times greater than the domestic greenhouse-gas benefits," note Gayer and Viscusi.

Since the environmental benefits play a clearly incidental role in the EPA's analysis, the vast majority of the estimated benefits rests on the assumption that Americans are irrational when it comes to buying automobiles. The EPA calculates that its proposed fuel economy standards would produce $444 billion in lifetime fuel savings, $71 billion in consumer surplus from additional driving, and $20 billion saved from less time refueling. But should fuel economy really be the paramount consideration when it comes to purchasing automobiles?

Gayer and Viscusi point out what is obvious to everyone except DOE and EPA regulators. Consumers value other attributes of automobiles including acceleration, handling, leg and head room, riding comfort, safety, braking ability, reliability, styling, and trunk storage. "Choosing a car other than a Toyota Prius, a Nissan Leaf, or a Chevrolet Volt is not an inexplicable quirk of individual behavior but generally stems from valuation of car attributes these models do not offer," observe Gayer and Viscusi. Not to mention their premium pricing relative to similarly sized and equipped conventional models.

In fact, a recent Massachusetts Institute of Technology study found that automobile fuel economy actually increased by 60 percent between 1980 and 2006, but at the same time the average curb weight of vehicles increased 26 percent, while their horsepower rose 107 percent. American consumers preferred to channel the fuel savings into bigger and more capable vehicles which means that average fuel economy only increased from 23 to just 27 miles per gallon. This hardly is irrational or an example of market failure.

In any case, do car buyers really myopically underestimate the lifetime costs of fueling automobiles? Not really. In a new National Bureau of Economic Research study, "Are Consumers Myopic? Evidence from New and Used Car Purchases" [PDF], the researchers conclude that "there is little evidence that consumers dramatically undervalue changes in expected future fuel costs." The researchers also review similar recent studies and report that after taking consumer preferences into account, there might be an annual welfare loss of $1 billion as a result of underestimating future fuel prices. To get a sense of the magnitude of this alleged loss, keep in mind that the sale of used and new vehicles totaled $635 billion in 2010 and motor fuel sales were nearly $300 billion [PDF]. And even if consumers are really totally unable to take into account future fuel costs, the EPA's mandate that each new vehicle carry a Fuel Economy and Environment Label surely addresses that problem.

Without the assumption of pervasive consumer irrationality, the costs of the EPA and DOE automobile fuel economy regulations are more than double their alleged benefits. Gayer and Viscusi also parse the benefit-cost analyses of new DOE regulations for clothes dryers, air conditioners, and light bulbs and they find again that the costs of the regulations outweigh the domestic environmental benefits once the assumption of consumer irrationality is dropped.

So why are regulators so eager to assume that Americans are irrational? Because they suffer from a bit of myopia of their own. "Agency officials who have been given a specific substantive mission have a tendency to focus of these concerns to the exclusion of all others. Thus, fuel efficiency and energy efficiency matter, but nothing else does," conclude Gayer and Viscusi. "Perhaps the main failure of rationality is that of the regulators themselves." Seems likely.