The Role of Behavioural Economics in Energy and Climate Policy

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Table of Contents

Introduction
Conceptual Understanding
Current Approaches
Potential (Or Actual) Use of Appropriate Techniques from Behavioural Economics
Arguments for the Use of Behavioural Economics
Arguments against the Use of Behavioural Economics
Conclusion
References

Introduction

“Can the insights of behavioural economics help fight climate change?” (Gunther 2009, p. 1). The above statement describes the question most economists have asked themselves as they try to formulate sound policy recommendations regarding energy and climate change.

The behavioural economic approach is considered unique to other conventional energy and climate change policies because policymakers usually focus on technology as the premise for formulating useful energy and climate change policies. The focus on technology has birthed many recommendations that propose the need to adopt more environmentally friendly technology such as solar power and wind power.

Since the use of environmentally friendly technology has been the focus for economic and environmental debates, the role of human behaviour in influencing energy and climate change policy has been rarely addressed. Amir (2005) observes that human behaviour can be a very useful tool for influencing energy and climate change policies “in particular the irrational, emotional, self-defeating, short-term, inconsiderate and plain old silly human behaviour that most of us engage in every day” (Amir 2005, p. 1).

Many tenets of human behaviour have interested behavioural economists as they explore different strategies for formulating effective energy policies. For example, the use of incandescent light bulbs instead of CFL light bulbs has been an interesting observation made by such researchers as they explore different human habits that have an impact on energy and climate policy (Reiss and White 2008).

Another interesting observation has been the popular focus on commodity prices as opposed to product lifecycle and the purchase of extraordinarily big houses (that consume a lot of energy) as opposed to moderately sized houses which are energy efficient (Gowdy 1998). A recent study by Pollitt (2011) reports that home energy choices and personal lifestyle choices account for close to 40% of the total energy consumption in America alone.

Consequently, this study has prompted economists to estimate that within the next decade, focusing on positive behavioural change can lead to a 20% to 30% reduction in energy costs (Pollitt 2011). Due to the unique human behaviours present in today’s society, it is difficult to ignore the impact behavioural economics have on energy and climate policy.

Energy and climate policies can, therefore, be improved by focusing on the contributions of positive behavioural economics on energy policies. This paper focuses on exploring the current situation concerning behavioural economics and climate policy. Subsequently, this paper seeks to investigate the potential (or actual) use of appropriate techniques from behavioural economics and the impact such a methodology may have on initiating positive behavioural change (viz-a-viz energy and climate policy).

Finally, to be fair to proponents and critics of behavioural economics (as a process of influencing climate and energy policies), this paper will also review the arguments for and against the use of behavioural economics. These analyses will be done sequentially. However, to improve the understanding of the research problem, it is crucial to have a proper conceptual understanding of the research problem.

Conceptual Understanding

The role of behavioural economics in predicting energy demand and energy efficiency has often been contrasted with insights from neo-classical theorists (Camerer 2004). As explained in earlier sections of this paper, behavioural economics borrows from psychological influences of human behaviour (to explain the power of economics).

Neo-classical theorists often propose the view that maximum utility can be realised through exponential discounting (Pollitt 2011). This outcome is often realised when agents have free access to information. Partially, the same outcome is also perceived as a parsimonious model of how economic decisions are made, but empirical research studies have shown that there is a big difference in the outcome of traditional models and behaviour induced models (Gowdy 2007, p. 2).

Explicitly, traditional models have tried to explain many things, including the varied reasons for high returns on equity (as opposed to bond returns), why there are many untapped methods for reducing energy demand (through energy-efficient policies) and why people prefer to pursue short-term gains at the expense of long-term gains (O’Donoghue and Rabin 2000).

From the weakness of neoclassical economists, behavioural economics has emerged as an alternative way to model decision-making because this alternative model is more congruent with empirical experiments (predicting human behaviour) and it has a higher accuracy when compared to other models founded on neo-classical ideals (Pollitt 2011).

Current Approaches

Even though there has been a strong appeal to consider behavioural economics as a crucial predictor of energy and climate policies, traditional economists often focused on the impact prices have on consumer behaviour (Hanser 2010). Consequently, many economic and environmental debates have been characterised by how much energy can be saved by increasing the price of environmentally unfriendly goods.

Companies and institutions have also embarked on purchasing energy-efficient appliances and machines. The same trend has trickled down to households. However, after comparing the “price” approach to the previously mentioned influences of behavioural economics on climate and energy policies, it is correct to say that traditional economists have reversed the study of behavioural economics to be an aftermath of energy prices as opposed to a precursor to energy prices.

Furthermore, traditionally, economists and psychologists have affirmed that non-pecuniary interventions on energy and climate change policies have often compared favourably to financial interventions aimed at influencing consumer behaviour (Pollitt 2011).

Through the same analysis, it has been affirmed that judiciously applied pecuniary interventions have significantly increased the efficiency of financial interventions aimed at influencing consumer behaviour. Consequently, many researchers have had an increased interest to understand the power of behavioural economics on consumer behaviour. Precisely, the increased interests of such researchers have been seen in the current understanding of public health, public finance and public law.

Potential (Or Actual) Use of Appropriate Techniques from Behavioural Economics

Issues of energy conservation and energy efficiency have featured prominently in many of today’s political and economic debates (Newell and Stavins 2004, p. 79). However, climate change concerns have elevated these issues to the forefront of policy dialogue. In a 2010 report made by the international energy association, it was estimated that close to 35% of the global decrease in carbon emission would be solely attributed to energy efficiency (Pollitt 2011).

Consequently, renewed focus on climate talk has been on the manner people use energy and the criteria used to make energy-efficient choices. Undoubtedly, the extent of energy conservation or energy efficiency anticipated in the coming decades largely depends on consumer interventions and behaviour.

From this understanding alone, Pollitt (2011) observes that the role of consumer behaviour in making energy choices has generated a keen interest in the development of energy policies and recommendations because consumer choices have a strong impact on energy demand.

In addition, consumer behaviours have a strong effect on assessing the effectiveness of energy policy interventions. From this understanding alone, it is correct to say that behavioural economists can offer new perspectives that influence policy design (Pesendorfer 2006).

However, even as policymakers ponder on new ways to better formulate energy policies, it should be understood that energy policies do not only revolve around the realms of climate change because other factors such as the security of energy supply and energy affordability also play a vital role in energy policy.

Through this understanding, Gunther (2009) explains that “Climate policy significantly interacts with both forms of these elements of energy policy via the introduction of expensive and intermittent renewable electricity and heat” (p. 1).

From this statement, Gunther (2009) proposes that if energy demand is subject to consumer behaviour, consumer behaviour can be used as a start to induce renewable energy choices. Nonetheless, it is also vital to point out that if issues of energy supply and affordability are ignored, it is going to be difficult to realise the full potential of revised energy policies.

De Martino (2006) observes that based on the understanding that the model of extreme rationality has significantly failed to predict (correctly) human behaviour; there is a strong need to introduce a new methodology that correctly predicts human behaviour.

Issues of energy demand and climate change are complex activities, which cannot be correctly understood by a simple application of rational behaviour. This understanding sets the ground for replacing the rational actor model by models that incorporate the regularities of human behaviour. This is where behavioural economics sources its strength.

Focusing on energy and climate policy, the potential of behavioural economics in mitigating the impact of global warming and decreasing energy demand is only limited by our imagination. To understand this statement, it is essential to think beyond rational choice and optimisation. Economists have in the past failed to offer the right guidance on the ways to limit fossil fuel use, beyond the strategies adopted in market situations.

However, as Gowdy (2007) observes, energy and climate issues go beyond this understanding. The reasoning behind this statement stems from the fact that people living in the world today may postpone future environmental gains for lavish short-term gains like driving big cars, living in lavish houses, going for expensive holidays (and similar lifestyle choices). The environment is left to choke at these choices.

Global warming is, however, a complexity of the interaction between environmental well-being and economic production. Therefore, issues such as the increase of prices or the introduction of carbon taxes are mere secondary concerns in the entire debate.

However, this statement does not imply that such policies are ineffective; there is only a stronger need to go beyond public policy rhetoric that assigns property rates and raises commodity prices (Gowdy 2007). Here, the perception should be that incentives should not just be prices but a culturally conditioned situation that is characterised by human behaviour.

Another plausible argument for weighing the potential of behavioural economics in climate change talk is the criticism levelled against introducing monetary incentives. Relying on assumptions that monetary incentives are likely to show the desired outcomes that positive climate talk seeks to realise is a flaw (Gowdy 2007). In fact, behavioural studies show that sometimes, the mere mention of money may hinder the realisation of social good (Gowdy 2007).

These studies have further affirmed that financial incentives can possible crowd out urges of civic responsibility among individuals. Consequently, it is correct to point out that monetary incentives can discourage the behaviours needed to solve communal problems like climate change or similar socio-economic issues. Therefore, contrary to the policy recommendations advanced by most economists today, purely relying of financial incentives may have a perverse effect on climate change.

Arguments for the Use of Behavioural Economics

Behavioural economics has shown a lot of potential to the understanding of how we can mitigate the effects of climate change. This potential lies in the uniquely humanistic attribute of realising cooperation across a sea of diversity. For example, human beings can cooperate across cultures, geographical spaces and generational divides, thereby elevating the human species to be extensively superior to other mammals.

Tapping into this potential outlines the advantages that can be realised by adopting behavioural economics. Research outcomes have changed dramatically after the adoption of behavioural economics because behavioural economics has instituted the adoption of experiments to explore different outcomes (Gowdy 2007).

For example, as explained in earlier sections of this paper, traditional axioms of human behaviour have been tested by the adoption of behavioural economics and the findings have shown that traditional models fall short of human behavioural outcomes.

Consequently, it is untenable for economists to claim that human behaviour is specifically motivated by rational choice. Similarly, it is even more difficult for economists to claim that human behaviour follows the law or any other tenet of rational behaviour (Loewnstein 2004).

Behavioural economics bears a strong understanding of how climate change and energy policies can be properly formulated because it touches on the very premise that influences climate change – human behaviour (Shogren and Taylor 2008).

Therefore, there is no better basis for understanding energy policies than through the comprehension of human behaviour. For example, the influence of social norms on understanding household economic behaviour has been studied by researchers to explain the influence of behavioural economics on energy consumption (Pollitt 2011).

The practicability of such studies has been witnessed through efforts by certain global organisations to change household energy consumption by availing information regarding the consumption of other people as an indicator of the influence of social norms on household energy demands. The results of such studies have been largely successful.

In a study done by Nolan (2008) on Californian households in the US, it was established that placing door hangers describing various energy conservation messages had a stronger impact on the reduction of energy demand as opposed to placing door hangers, which shared energy conservation tips. The difference in the reduction of energy demand between these two experiments was reported at 10% (Pollitt 2011, p. 12).

These findings mirror similar findings by an American company known as OPOWER. OPOWER did an experiment on 600,000 American households where it posted reports showing the differences in energy consumption among neighbourhoods. In the same study, the households were given energy conservation tips.

The study included the participation of 23 utilities in the US. Six of these utilities were deemed the largest in the country. After completing the study, it was reported that there was a 1.11% to 2.78% reduction in energy consumption among the households.

The reduction in energy demand (cited in the above studies) shows the true effect of behavioural economics on energy conservation and energy demand. These parameters have a stronger impact on mitigating the impact of climate change. Costa and Kahn (2010) did a follow-up study on the OPOWER experiment and found out that the results were heterogeneous among the households included in the study.

The true effect of the experiment was, however, seen to be more effective for liberal households that conservative households. Nonetheless, it was evident from the experiments that the true effect of behavioural economics on motivating viable policy alternatives was undisputable.

Arguments against the Use of Behavioural Economics

Some of the arguments levelled against the use of behavioural economics in influencing energy policies stem from the extent of influence behavioural economics have on energy policy.

Some researchers such as Loewenstein and Ubel (2010) observe that it is not right to rely on policy interventions, which are purely based on behavioural economics because the energy savings generated from such interventions are dismal. For example, concerning the OPOWER experiment, Loewenstein and Ubel (2010) observe that it would probably be more beneficial to introduce carbon tax as a measure to reduce the impact of global warming.

There have also been some conceptual weaknesses of behavioural economics, which have been identified to strengthen arguments against it. For example, Pollitt (2011) observes that the greatest weakness of behavioural economics literature is its violation of the rational actor model as an “anomaly”. Researchers explain that the rational mind is often embroiled in a tag of war with the emotive mind (Ostrom 1998, p. 1).

Proponents of behavioural economics rely on this view to explain the influence of the methodology on economic issues. However, biologists and neurobiologists oppose this view by explaining that the human brain is a unified system that is characterised by complementary parts as opposed to conflicting parts (Glimcher 2005).

Therefore, the “anomalies” presented above are in fact, what distinguishes human beings from other animals. Interestingly, the rational actor model is deemed appropriate for other animals but not human beings (Arkes 1999, p. 591).

Conclusion

Effective energy and climate change policies have been very elusive for most policymakers. This paper proposes that, perhaps, the problem has been the ignorance of behavioural economic factors in the entire debate of climate talk. Behavioural economics is shown to be more effective in predicting human behaviour when compared to other models of predicting human behaviour (advanced by neo-classical theories).

Based on this strength alone, it has been much easier to adopt behavioural economics when trying to influence climate change positively. This paper cites studies, which have shown that behavioural economics have a positive impact of reducing energy levels among communities.

Its accuracy stems from the fact that it correctly predicts human behaviour. However, the strength of behavioural economics in influencing energy and climate policies hail from the fact that the methodology touches on the centre of climate change – human behaviour.

Therefore, influencing human behaviour is bound to have a strong effect on influencing positive human behaviour to realise positive environmental outcomes. Going forward, more studies need to be done to ascertain the extent that behavioural economics can have on realising the goal of having an environmentally consciousness society.

References

Amir, O 2005, ‘Psychology, behavioural economics, and public policy’, Marketing Letters, vol. 16, pp. 443-454.

Arkes, H 1999, ‘The sunk cost and concorde effects: Are humans less rational than lower animals?’, Psychological Bulletin, vol. 125, pp. 591-600.

Camerer, C 2004, Advances in Behavioural Economics, Princeton University Press, Princeton.

Costa, D & Kahn, M 2010, Energy Conservation “Nudges” and Environmentalist Ideology: Evidence from a Randomized residential electricity Field Experiment, National Bureau of Economics research, Massachusetts.

De Martino, B 2006, ‘Frames, Biases, and rational decision-making in the human brain’, Science, vol. 313, pp. 684-687.

Glimcher, P 2005, ‘Physiological utility theory and the neuroeconomics of choice’, Games and Economic Behaviour, vol. 52, pp. 213-256.

Gowdy, J 1998, Limited Wants, Infinite Means: A Reader on Hunter-Gatherer Economics and the Environment, Island Press, New York.

Gowdy, J 2007, Behavioural Economics and Climate Change Policies. Web.

Gunther, M 2009, When Behavioural Economics Meets Climate Change, Guess What’s Coming for Dinner? Web.

Hanser, P 2010, ‘On dynamic prices: a clash of beliefs?’, The Electricity Journal, vol. 23 no. 6, pp. 36–38.

Loewnstein, G 2004, Out of control: visceral influences on behaviour, Princeton University Press, Princeton.

Loewenstein, G & Ubel, P 2010, Economics behaving badly, Times, New York.

Newell, R & Stavins, R 2004, The Economics of energy efficiency, Elsevier, Amsterdam.

Nolan, J 2008, ‘Normative Social influence is under detected’, Personality and Psychology Bulletin, vol. 34 no. 7, pp. 914-923.

O’Donoghue, T & Rabin, M 2000, ‘The economics of immediate gratification’, Journal of Behavioural Decision Making, vol. 13 no. 2, pp. 233–250.

Ostrom, E 1998, ‘A behavioural approach to the rational choice theory of collective action’, American Political Science Review, vol. 92 no. 1, pp. 1–22.

Pesendorfer, W 2006, ‘Behavioural economics comes of age: a review essay on Advances in Behavioural Economics’, Journal of Economic Literature, vol. 44 no. 3, pp. 712–721.

Pollitt, M 2011, The Role of Behavioural economics in Energy and Climate policy. Web.

Reiss, P & White, M 2008, ‘What changes energy consumption? Prices and public preasures’, Journal of Economics, vol. 39 no. 3, pp. 636‐663.

Shogren, F & Taylor, L 2008, ‘On behavioural‐environmental economics’, Review of Environmental Economics and Policy, vol. 2 no. 1, pp. 26‐44.

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