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Friday, October 10, 2014

Should a government subsidise the purchase of energy-efficient equipment?

Today the Financial Express has a story, where LED bulbs costing Rs.400 will be sold at Rs.10 with the government paying for the difference. Does this make sense? I think it does not, and that this situation calls for a lot more sophistication in thinking about public policy.

What's the market failure?

The first and obvious place where this spending program fails to make the grade is on the question of public goods. I get a gift of Rs.390 to have a LED bulb, I benefit. The bulb is a private good. A gift to people who buy LED bulbs is as wrong as government spending on other private goods. Just as we criticise a government which runs health clinics for perambulatory care, we should criticise the government when it gifts money to people for the folks who buy LED bulbs. This is just the faddish thinking of one bunch of hausfraus running policy versus another.

The guiding question, in all design of government, should be: What's the market failure? I am not able to see a market failure in the working of the market for LED bulbs.

Get the prices right

Some people in the field of energy have an almost moralistic perspective on energy efficiency. Higher energy efficiency is seen as a good thing, regardless of cost. This is the wrong way to think about it. Energy efficiency is just one part of economic efficiency. An LED lamp is a big up front payment and then a stream of gains in the future. Whether the LED lamp is worth putting in depends on (a) The magnitude of each gain (i.e. how much you use that lamp) and (b) The discount rate. If the interest rate is high, it will make sense to buy a Tungsten bulb instead.

To obtain efficiency in the field of energy we should think about three things:

  1. The first is the question of pricing of energy. When energy is cheap, it will be squandered by consumers, and vice versa. Externalities should be priced in. The biggest externality that is not being priced in is carbon emissions. When we fix these mistakes, the price of energy will go up, which will encourage people to buy energy efficient equipment.
  2. When a household chooses to get capital goods of more or less energy efficient equipment, the flip side of these decisions are the capital goods that will be invested upstream, in the large factories of the energy industry such as generation utilities or natural gas infrastructure. Optimality requires that society should solve that overall problem correctly, and the overall problem is the combination of energy production, energy transportation and the end-devices which use energy. It is not obvious that the greatest bang for the buck is always obtained at the device end.
  3. For that overall problem to be solved correctly, consumers and energy companies should be hanging off a sensible financial system which shows interest rates to both which are internally consistent. The failures of the Bond-Currency-Derivatives Nexus in India hamper that. The interest rates seen by households (which determine their purchase of LED bulbs) are strange, and the interest rates seen by the energy industry are quite different and also strange.

The engineer in me marvels at LED lamps. I was thrilled when the 2014 Nobel Prize went to the geniuses who made blue LEDs; this is simply one of the great sagas of the 20th century. I have watched Shuji Nakamura ever since he moved to UCSB in 1999. But this `gee whiz' should not blind us on questions of public policy; we should be hard headed in how we thinking about what government does. Most of what government in India does is not the job of government; most of what government ought to do in India is not being done. The rocket science that we require in India is the great organising principle of the market economy -- the Bond-Currency-Derivatives Nexus.

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