Asymmetric Information on the Market for Energy Efficiency: Insights from the Credence Goods Literature.

AuthorLanz, Bruno

    Energy is consumed for the services it provides, and consumers need a technology to transform energy into these services. Energy efficiency measures how much of these valuable services can be obtained for a given unit of energy input. It follows that, by adopting more efficient energy-transforming technologies, consumers can potentially lower energy use without affecting the amount of services they consume. (1) Because of externalities associated with energy use, and in particular fossil resources that contribute to both local (e.g. airborne particulate matter) and global (e.g. carbon dioxide) emissions, many countries actively promote the adoption of energy efficient technologies in order to reduce energy consumption (Gillingham et al., 2016). As highlighted by Allcott and Greenstone (2012), these policies ought to target inefficiencies on the market for energy technologies. The existing literature emphasizes informational failures that affect investment behavior, including imperfect information about and inattention to future energy savings (see also Gerarden et al., 2017).

    We argue that, for a number of relevant energy-transforming technologies, the supply-side of the market may hold relevant information and have little incentives to share it with consumers. Based on this observation, this paper focuses on supply-side incentives associated with asymmetric information on the market for energy technologies and implied market inefficiencies. (2) As initially put forward by Sorrell (2004) and recently discussed by Giraudet (2020) and Plambeck and Taylor (2019), the type of informational asymmetry characterizing these energy-transforming technologies can be conceptualized under the notion of "credence goods," a class of goods for which consumers have incomplete knowledge about own needs both before and after purchase (Emons, 1997). For these goods, consumers have to trust information by an expert-seller who can perform a diagnostic and supply a particular product. In the case of energy-transforming technologies, consumers typically do not directly observe the level of energy efficiency of alternative technologies, and may not be able to ascertain which technology is cost-minimizing, both before and after purchase/installation. (3) In turn, when the supply-side of the market possesses an informational advantage, decisions to invest in energy-transforming technologies inherit the properties and inefficiencies identified in markets for credence goods.

    In Section 2 we start by considering energy efficiency investment decisions in relation to the basic credence goods model of Dulleck and Kerschbamer (2006). This framework allows us to identify sources of inefficiencies associated with credence goods, and discuss "baseline" results from the seminal implementation of credence goods markets in the laboratory by Dulleck et al. (2011). In the next step, we relate the framework of Dulleck and Kerschbamer (2006) to the simple model for energy efficiency investments by Allcott and Greenstone (2012), clarifying which aspects of investment decisions are likely to be affected by informational asymmetries. This delivers the main contribution of this work, namely identifying how and when inefficiencies studied in the credence goods literature translate in the context of energy efficiency investment decisions, and how the credence component of energy-using technologies can affect market efficiency.

    Conceptually, the credence goods framework provides a supply-side perspective on the observed tendency of consumers to invest "too little" in energy efficiency, seemly failing to realize financial benefits from energy savings Jaffe and Stavins, 1994a). Indeed, theoretical studies on credence goods such as Emons (1997) and Dulleck and Kerschbamer (2006) suggest that asymmetric information induces a reduction in trade volume on credence goods markets. The necessity to trust expert-sellers comes from the possibility of inefficient supply-side behavior, which can be classified under three possible outcomes: (i) expert-sellers supply a lower quality than what the consumer needs (undertreatment), (ii) the quality supplied is higher than what is needed (overtreatment), and (iii) expert-sellers charge for goods or services that are of higher quality than what is actually supplied (overpricing). While asymmetric information is only one of the factors affecting the energy efficiency gap, and may not affect all consumers and technologies equally, understanding how the market fails in relation to supply-side incentives is important for the design of public policies. (4)

    Dulleck and Kerschbamer (2006) suggest two institutional features of credence goods markets that can potentially restore market efficiency without external intervention. First, verifiability refers to a case in which consumers are able to verify the characteristics of the product after purchase/installation. Second, liability represents a case in which expert-sellers are liable to solve the consumers' problem. Under specific conditions, which we discuss below, either verifiability or liability leads to efficient trade in markets for credence goods. For many energy efficiency investments, however, neither verifiability nor liability are likely to solve the information problem. The key reason is the difficulty (or costliness) for consumers to ascertain, for each possible technology available on the market, actual energy savings that will be achieved. Also ex-post, after purchase and/or installation, measuring energy use per unit of service and defining a valid counterfactual remain a challenging endeavor (see e.g. Joskow and Marron, 1992; Burlig et al., 2020). Realized energy savings are influenced by exogenous factors (e.g. the weather) and endogenous factors (e.g. changes in the demand for energy services). This leads us to discuss energy performance contracting as a way to align supply- and demand-side interests (see e.g. Sorrell, 2007; Klinke, 2018). However, insights from the credence goods literature suggest that the difficulty to credibly quantify energy savings for many relevant energy-transforming technologies limits the range of application of performance contracting.

    In Section 3, we turn to a review of the empirical evidence from the credence goods literature, building on the work of Kerschbamer and Sutter (2017). This part of the paper overviews results from experimental markets for credence goods, as well as field evidence for products such as car repairs, taxi rides, and medical treatments. (5) Our objective is to use the drivers of market inefficiencies identified in the credence goods literature to organize and discuss selected contributions to the energy efficiency literature. This affords the second main contribution of our paper, which is to provide a rejoinder of two separate but related streams of the economics literature, and thereby offer a novel perspective on supply-side incentives underlying investment decisions in energy-transforming technologies. (6)

    Concretely, we consider four important characteristics that affect supply-side behavior in markets for credence goods. First, we discuss the degree of informational asymmetry between consumers and expert-sellers, and the conditions under which mitigating the information gap reduces market inefficiency. Experimental evidence by Balafoutas et al. (2013) suggests that consumers who signal to be informed about the characteristics of a credence good are more likely to receive a correct treatment. In the context of energy efficiency, informing consumers is directly related to the use of energy efficiency labels and certification (see e.g. Newell and Siikamaki, 2014). Our reading of the literature leads us to emphasize the trust component in energy efficiency labels, and the role for independent third parties (or competing experts) to test whether the actual energy intensity of technologies corresponds to the certified energy efficiency. Moreover, in an effort to enforce trust on the market for energy efficiency, we highlight the need to make suppliers liable to deliver products that are in line with the certification.

    The second dimension of credence goods markets we consider is the necessity to carry out a diagnostic, and the ensuing possibility to separate diagnostic from treatment. In the context of energy efficiency, this can take the form of independent energy audits. Supply-driven inefficiencies are expected to decrease if one expert is paid to perform the diagnostic and another expert is paid to perform the treatment, as the diagnosing expert has no incentives to recommend inappropriate products. The literature on credence goods, however, suggests that separate diagnostic can also worsen inefficiencies because it introduces an additional cost to market participation (Greiner et al., 2017; Mimra et al., 2016). We further discuss the possibility of ex-post auditing (Allcott and Greenstone, 2017) as another approach to improve market efficiency in a credence goods framework. Policies that lower the cost of third party audits, both before and after purchase/installation can mitigate the credence component of energy technologies and favor trust in the behavior of expert-sellers.

    Third, we discuss how third party reimbursement reduces market efficiency in credence goods markets (e.g. Kerschbamer et al., 2016; Balafoutas et al., 2017). In particular, empirical evidence shows that experts are inclined to overtreat and overprice consumers whenever a third party (e.g. an insurance) covers the cost of the treatment. The use of subsidies for energy efficient technologies makes these results highly relevant for the design of energy and environmental policy. We relate results from credence goods markets to empirical evidence on consumer subsidies and sales incentives studied by Allcott and Sweeney (2017). Overall, this suggests that the presence of asymmetric information diminishes the...

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