NC Ch 13 : Making Markets Work

This chapter is about economic theory, and why markets do not work perfectly.

It then describes main sources of market imperfections, which are capital misallocation, organizational failures, regulatory failures, informational failures, value-chain risks, false or absent price signals, incomplete markets and property rights.

Capital misallocation - where short term gains (lower initial capital costs) take priority over longer term savings. "Typically, energy-saving devices are chosen by engineers at the firm's operating level, using a rule-of-thumb procedure called 'simple payback,' which calculates how many years of savings it takes to repay the investment in better efficiency and start earning clear profits" (p267) "One remedy is to teach the energy engineers how to speak financial language. When the engineer goes to the comptroller and says, 'Wow, have I got a deal for you - a risk-free return of 27% after tax,' it sounds better than a 3.4 year payback." Actually, I don't understand what that means. I guess I am one of those engineers who need to learn financial language.

Potential ways for people to invest in energy savings - 1997 creation of the International Performance Measurement and Verification Protocol, "standardizes streams of energy- and water-cost savings (in buildings and industrial processes) so they can be aggregated in securitized, just as FHA rules standardize home mortgages. Also, the Energy Service Company (ESCO) concept, where entrepreneurs charge nothing up front for their services but are paid by sharing the measured savings they achieve. These schemes can encourage people to buy compact fluorescents and for households to install solar panels.

Organizational failures - when the risks of making a decision outweigh the potential rewards because of the organizational structure of the company or group. Managers feel disinclined to fix an obvious inefficiency since they're not directly responsible for it and have other priorities. Columbia University's new energy director Lindsay Audin started saving $2.8 million a year, 60% in lighting alone, won 9 awards and $3 million in grants and rebates, and brought 16 new efficiency products to market. For more information on organizational economics, look to Herbert Simon. In order to avoid systematic suboptimization, create broader alignment between corporate and personal objectives.

Regulatory failures - one big problem is that standards are often interpreted as floors for compliance instead of inspiring people to meet and exceed expectations. For example, electrical wiring for buildings should use fatter wire for more energy efficiency, but thinner wires are cheaper, which is also an example of 'split incentives,' where people choosing technologies aren't the same people who pay the bills. Some ways to entice people to do better are to offer those who are trying to overcomply to jump ahead in the queue for approvals, which costs nothing, but is valuable for companies.

Informational failures - voluntary label programs are helping people make better decisions like EPA's Green Lights by creating competitive advantage.

Value chain risks - companies are hesitant to commit to volume production because they are unsure that there is enough consumer demand. "Hans Nilsson, then an official of Swedish energy-efficiency agency NUTEK, pioneered contests for bringing efficient devices into the mass market. A major public-sector purchasing office, Statskontoret, would issue a request for proposal, which committed to buy a large number of devices, bid at certain prices, if they met certain technical specifications, an explicit expression of market demand" (p277). "In 1988, B.C. Hydro started paying distributors a small, temporary subsidy to stock only efficient models of motors, covering their extra carrying cost, since risk-adverse distributors are disinclined to stock new products that they aren't sure people will buy. In three years, premium efficiency motors' market share soared from 3% to 60%."

False or absent price signals - differences in price levels as well as price structures can help people make better decisions. We want to "get incentives right so that rewards are granted for what we want - lower bills - and not the opposite - higher sales" (p278).

Incomplete markets and property rights - one market that needs to be developed is the one in saved energy or "negawatts." "Use it or lose it" water laws to allow waved water to be sold or leased without penalty, in CA, OR, and Montana.

POLICY to address these major sources of market problems.

"1991, Bush signed Intermodal Surface Transportation Efficiency Act, which mandates least-cost choices for solving local transportation needs, thus allowing federal transport dollars to flow to the best buys, not only to highways."

Resource consultant Dr. Mohamed ElGasseir, and financial adviser Andrew Tobias propose "pay at the pump" car insurance. This is certainly an interesting if seemingly farfetched idea that seems to make sense on the surface.

Need more accountability and transparency in international trade agreements.

Create more information feedback loops. Dr. Jeremy Leggett, introduced senior climate scientists to leaders of the European insurance and reinsurance industry.

Cybernetics - science of communications and control in machines and living things, may be able to help us set better feedback loops and also goals. For example, companies could publish an Alternative Annual Report, to compare what actually happened in the previous year to what could have happened.