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Rationale for government intervention in energy efficiency

If energy efficiency is cost-effective, why must governments support energy efficiency investment with public funds? Energy efficiency improvement is often hampered by market, financial, informational, institutional and technical barriers. These barriers exist in all countries, and most energy efficiency policies are aimed at overcoming them. Many governments cite the contributions of energy efficiency to sustainable development and energy security as justification for such policy interventions. Societal or public-good benefits cannot be captured by private parties making energy efficiency investments, thus further justifying government support.

The energy efficiency underinvestment gap due to market failures and other barriers is immense. The IEA estimates that annual investments of USD 300 billion in energy-efficiency improvements are needed globally, in combination with a rising price on CO2 emissions and support to low-CO2 supply technologies, to reduce greenhouse gas emissions to a level that would deliver a concentration of 450 parts per million (ppm) (IEA, 2009).

Classical economic theory holds that if energy pricing is right, reflecting externalities resulting from production and consumption, the market should ensure sufficient investment in energy efficiency. Table 1, however, lists market failures related to energy efficiency which cannot be corrected by pricing, and lists the policy interventions used by governments to overcome them. Additional non-pricing policies are needed to close the energy efficiency investment gap (IEA, 2011).

Table 1

Market failures affecting energy efficiency which cannot be addressed with pricing policies

Table 1

Market failures affecting energy efficiency which cannot be addressed with pricing policies

Market failures and other barriers

Intervention policies

Imperfect information

Labelling schemes, education and awareness

Prices set below costs

End-use regulation, subsidies

Principal-agent and split incentive problems

End-use regulation, subsidies, obligations

Behavioural failures

Standards and labelling, regulation, education

The policies listed in Table 1 require government funding to implement. Standards and labelling policies require procedures to determine the technical performance of energy-consuming products through product labelling and testing. Informational and educational programmes to build energy efficiency awareness can be expensive to develop and deliver. Fiscal policies such as subsidies and tax incentives for energy-efficiency investments are an even greater drain on government budgets.

Reliable funding is essential to support government policy interventions in energy efficiency. Governments have options as regards how energy efficiency policy is funded (IEA, 2010). Different mechanisms have advantages and disadvantages, which can be compared along political economy and classical economics axes (Table 2).

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