Discussion Paper

Bridging the Energy Efficiency Gap: Policy Insights from Economic Theory and Empirical Evidence

Oct 17, 2013 | Kenneth T. Gillingham, Karen L. Palmer

Summary

In this review of the energy efficiency gap, experts analyze reasons why the size of the gap may be overstated, economic explanations for such a gap, and recent evidence from behavioral economics on why an efficiency gap could exist. This paper was also published in the Review of Environmental Economics and Policy.

Abstract

Despite several decades of government policies to promote energy efficiency, estimates of the costs and benefits of such policies remain controversial. At the heart of the controversy is whether there is an "energy efficiency gap," whereby consumers and firms fail to make seemingly positive net present value energy saving investments. High implicit discount rates, undervaluation of future fuel savings, and negative cost energy efficiency measures have all been discussed as evidence of the existence of a gap. We review explanations for an energy efficiency gap, including reasons why the size of the gap may be overstated, neoclassical explanations for a gap, and recent evidence from behavioral economics that has potential to help us understand why a gap could exist. Our review raises fundamental questions about traditional welfare analysis, yet we find the alternatives offered in the literature to be far from ready for use in policy analysis. Nevertheless, we offer several suggestions for policymakers and for future economic research.