Economics 101: Is energy-efficient housing a waste of money?

Human nature plays a role in various industries

Many countries have started to introduce energy-efficient building codes as part of global efforts to reduce pollution and combat global warming. The fact that they can generate financial savings means households and organisations are often willing to implement energy-efficient modifications to their construction projects independent of any broader environmental benefits. But are the sometimes costly investments worthwhile?

A recent study by Lucas Davis from the University of California at Berkley, Sebastian Martinez and Bibiana Taboada - both at the Inter-American Development Bank - suggests that the electricity usage in houses with energy-efficient upgrades may be indistinguishable from that of regular houses. Their findings came as a shock to many observers, since the engineering estimates for the effects of the upgrades were a 26 per cent decrease in electricity usage. What accounts for the apparent failure of the energy-efficient housing?

The study was conducted in a part of Mexico with hot, dry summers, making the homes ideal test cases for a variety of energy-efficient enhancements, such as insulation. The researchers were able to instal a variety of sensors that gave them incredibly accurate data on conditions inside the houses, allowing for unusually definitive conclusions on the impact of the efficiency upgrades.

In a blow to the efforts of green campaigners, the researchers found that the upgrades, which cost around $500 per house, had no discernible effect on electricity usage in the houses. There were two primary reasons.

First, engineers significantly overestimated the adoption of air conditioners; the poverty of the area compared to rich neighbourhoods in western countries may have accounted for this.

Second, during the summer, the occupants of the houses would invariably open their windows in the pursuit of air flow, heavily undermining the effectiveness of the efficiency upgrades.

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Drawing the conclusion that energy-efficient building codes are a waste of time would be a grave error, however. Instead, what this study showed us is the need for engineering models to exhibit greater flexibility, as different locales can exhibit a wide variation in the baseline parameters used in those models. In the case of the Mexican houses, it was the underutilisation of air conditioners compared to expectation; but it could be any one of a broad range of differences when applying these models elsewhere.

Notably, policymakers and activists need to be wary of conflicts of interest, since the suppliers of efficiency upgrades may present the results of models calibrated to optimal conditions to maximise the projected impact, and then “forget” to mention that in the likely application circumstances, the benefits will be much smaller.

More importantly, the results of Davis’ et al’s paper also indicate the need for greater co-operation between engineers and economists in the development of models. Economists specialise in studying human behaviour, and relating it to the incentives that different policies can create. They often develop very nuanced models of “unintended consequences” of various rules and regulations, that can explain counterintuitive results. In contrast, engineering models emphasise the physical characteristics of the environment at the expense of the behavioural ones, as they naturally play to their strengths.

Though it is outside the engineering domain, the 1973 Endangered Species Act is an example of the sort of policy errors that can emerge when analysts fail to incorporate the tools of modern economics in their models. In an attempt to protect a variety of endangered species, the US government passed a law allowing it to seize lands where an endangered species is found, and to transform them into conservation areas to protect the species.

At first sight, this seems like a sensible way of addressing the extinction threat faced by a variety of animals. Unfortunately, it backfired, leading to what became known as the “shoot, shovel, and shut-up” phenomenon: fearful of having their property seized, landowners zealously searched their lands for endangered species, with the aim of slaughtering all specimens before they can be found by government officials. In other words, the rate of extinction accelerated. Economists are trained to anticipate these kinds of mishaps, which is why policymakers are often keen to run their proposals by economists.

The broader lesson, however, is that many- if not most - policies fail to go to plan, because the world is very complicated, especially the parts that depend upon the behaviour of humans. The complexity and unpredictability is sometimes seized upon by “virtue-signalling” people, who openly support a pro-social policy to convey to their peers that they care about others - a desirable personal trait. This support can lead to the adoption of policies by people who care much more about the image that they portray than the underlying effectiveness of the policy.

Domains such as health, the environment and taxation are plagued by many such exponents, who inadvertently contribute to counterproductive policies such as the endangered species act. It took many years for US policymakers to realise and rectify their error. And as the economists studying energy efficiency in Mexico showed, the only rigorous scientific safeguard is to collect data systematically, no matter how obvious it seems at the outset that a policy is going to work.

Omar Al-Ubaydli @omareconomics is a researcher at Derasat, Bahrain