Discussion Paper

Confronting Regulatory Cost and Quality Expectations: An Exploration of Technical Change in Minimum Efficiency Performance Standards

Nov 6, 2015 | Margaret Taylor, C. Anna Spurlock, Hung-Chia Yang

Summary

Minimum energy performance standards remove certain product models from the market that do not meet specified efficiency thresholds. This paper addresses the related interaction between regulation and innovation as well as cost and benefit expectations.

Abstract

The dual purpose of this project was to contribute to basic knowledge about the interaction between regulation and innovation and to inform the cost and benefit expectations related to technical change which are embedded in the rulemaking process of an important area of national regulation. The area of regulation focused on here is minimum efficiency performance standards (MEPS) for appliances and other energy-using products. Relevant both to U.S. climate policy and energy policy for buildings, MEPS remove certain product models from the market that do not meet specified efficiency thresholds.

This project took the form of a retrospective review of regulation, which is a type of detailed case study that compares data on ex ante (i.e., before regulation) expectations about regulation to ex post (i.e., after regulation) observations of regulatory performance so that empirical evidence can guide future rulemaking decisions. This project differs from other retrospective reviews, however, in its focus on regulatory expectations and post-regulatory outcomes of technical change, which is a particularly important factor in the performance of MEPS, as it is in other areas of regulation. It also differs from other retrospective reviews in its focus on five products with different regulatory histories, namely room air conditioners, refrigerator-freezers, dishwashers, clothes washers, and clothes dryers. These five products, which heavily saturate U.S. households and are manufactured in a highly concentrated industry sector, are the full set of large household appliances which were subject to federal MEPS informed by rulemaking analyses conducted by the Department of Energy (DOE) from 1990 to 2012. The research advantages of focusing on these appliances in this time period include limiting selection bias, ensuring the likelihood of sufficient data for retrospective review, and limiting variation in product markets. Finally, this project differs from other retrospective reviews in the scope of data employed. Ex ante data included rulemaking analyses and other documents in the regulatory docket. Ex post data included rich, often high resolution data covering several aspects of product price, quality, and design: (1) extensive 2003-2011 U.S. point-of-sale data on appliance models matched to model energy use data (for all but clothes dryers) which facilitated construction of a monthly panel of model-specific prices, quality characteristics, and market shares; (2) author-constructed datasets from independent third party appliance testing and product reliability surveys; and (3) an author-constructed dataset of the features identified in the product manuals of 1,109 clothes washer models sold in the U.S. in 2003-11 (these models represented 95% of the identifiable models in the point-of-sale data, which account for 29% of U.S. units sold over that period).

At least seven questions were addressed in this project, which cluster around considerations of whether and how product price, quality, and design changed after regulation. Six of these questions were informed by hypotheses drawn from various literatures; the seventh was fully exploratory, with respect to how well the MEPS rulemaking analysis process treats product design. Key findings, which were generally consistent with hypotheses, included: (1) MEPS rulemaking analyses significantly overestimated observed product prices; (2) the energy efficiency of products purchased after regulation generally exceeded the regulated standards (as well as rulemaking expectations of market share for the one case appliance for which these expectations existed); (3) unregulated aspects of product quality at the time of sale often improved in conjunction with MEPS events, at least according to available models reported on in third-party testing; (4) product reliability generally improved over the period of time the products have been regulated; (5) within-model price declines (i.e., product-level price declines without consideration of model entry or exit) occurred across products, and these declines were better differentiated by product architecture than by energy efficiency levels for the two products we analyzed; (6) the dominant design of one product, clothes washers, adapted in only a few years to MEPS that were originally expected to be so “technology-forcing” that they were deemed likely to eliminate that design from the U.S. market; and (7) for one product, clothes washers, highly correlated product features contributed both to regulatory performance and to unregulated aspects of product quality.

These findings had several potential implications for the MEPS rulemaking process; these revolve around statutory language that the targets of efficiency standards should be “the maximum percentage improvement” that is “technologically feasible and economically justified.” Our results indicate several possible implications of relevance to the economic justification of MEPS, including: that the positive economic impacts of MEPS on consumers may have been underestimated; that the initial price of efficient products may not be of as great a concern as its analytical priority in the rulemaking process suggests, given the existence of lower-than-expected product prices that decline as regulated models remain on the market; that the projected energy savings of MEPS may have been underestimated; that the MEPS process may have generally succeeded in ensuring the retention of product utility and performance under regulation; that the part of regulated product maintenance costs that is tied to significant repair events may have declined over time across products; and that the concept of product architecture may be more useful to technical elements of MEPS cost analyses than a disaggregated approach to product design at the level of product features (i.e., design options, product components, etc.). Our results also raise questions of: what makes a product architecture more or less adaptable to a stringent standard; how can the MEPS technical feasibility criteria better avoid a present-day bias in identifying efficiency-enabling design options and overly pessimistic expectations about future commercial viability; and what are the most appropriate combinations of design options for developing cost-efficiency relationships.

Finally, our results point to several areas for new research on the relationship between regulation and innovation. These include: the connection between the details of regulation and our observed post-regulatory price, efficiency, quality, and reliability outcomes; a mechanism that could underlie the Porter Hypothesis; issues related to the political economy of “technology-forcing,” “performance-based,” and “technology-based” regulation in the MEPS context; unpacking information asymmetry in the MEPS rulemaking process; and the role of human behavior in regulatory cost and benefit errors.