Energy efficiency and the limits of market forces: The example of the electric motor market in France

Abstract

This paper addresses the limits of market forces as the exclusive driving force for energy efficiency. The electric motor market in France is analysed, with particular emphasis on the structure and functioning of the market, as well as the decision-making practices of the main agents. The study shows that market forces are constrained by the variety of transaction types and by the decision-making practices of agents, in an environment characterised by lack of information and split incentives for adopting energy-efficient technological options. The paper argues that public intervention is a necessary condition for organising the market and promoting energy efficiency. The article points out the main obstacles to the diffusion of efficient electric motor technologies and suggests some initiatives for market transformation.

Introduction

There are two kinds of general purpose electric motors available in the market place today: standard motors and high-efficiency motors – HEMs. This latter technology was introduced in world markets in the late 1970s after the oil crisis. In 1995, these motors represented 20% of induction motor production and sales on the American market.¹ In Europe, however, they still have a negligible market share.² This discrepancy in the market share between North America and Europe can be attributed to the absence of active market transformation initiatives in Europe.³ Considerable potential for energy saving through the diffusion of HEM technology has been identified and a large share of this potential corresponds to opportunities where investment payback time is very attractive. Although a $2000 investment in a motor represents expenditure in electricity that might reach $50000 over the motor’s lifetime, the investment cost is often considered to the detriment of lifetime cost. It is widely accepted that agents frequently do not consider the total cost of the service. An intriguing question for economic analysts is ‘Why do economic agents neglect opportunities to increase their profits through energy efficiency?’

Energy economists have traditionally explained agents’ failure to optimise their choice of technology by pointing to market failures.⁴ The key market failures traditionally mentioned in the literature⁵ are: inadequate market regulation, leading to pricing distortions, agents’ imperfect information,⁶ asymmetric information, supply infrastructure limitations, and imperfections in capital markets.⁷ This Neoclassical approach considers that, in cases where the market fails to provide adequate information or signals, agents will require higher rates of return to compensate for the greater risks associated with the uncertainty level. Firms and individual consumers are assumed to be rational agents and to have profit-maximising behaviour. This approach maintains that agents are able to change their investment choices if the market failure to provide accurate information is corrected. Hence, if the problem of imperfect information or signals were solved, agents would be more certain about energy saving investments and would require lower rates of return, making these investments viable.⁸

This approach has been used by energy economists to build an efficiency supply curve, which is based on a sequence of energy conservation opportunities with increasing costs.⁹ These costs are associated with the costs of correcting market failures, assuming that once the market failures are corrected rational consumers will strive to close the efficiency gap.¹⁰ However, in the history of DSM programs, the cost of ‘negawatts’ has frequently exceeded the estimates of the efficiency curves.¹¹ DSM case studies have related the excess in negawatt costs to structural market barriers or behavioural barriers that cannot be corrected within the framework of market forces. In other words, empirical markets may have a certain number of barriers to cost minimisation, even in a situation where all market failures are corrected. These barriers are linked to the insufficiently rational behaviour of agents, which means that there are market limits to achieving optimum resource allocation.

Economists have developed an alternative approach to the Neoclassical theory to explain the failure of agents to maximise their objective function. This approach is based on the concept of bounded rationality.¹² The basic hypothesis of the concept of bounded rationality is that agents’ behaviour is limited by lack of knowledge, which cannot be expressed in terms of probability. This approach assumes that ‘there is (…) a fundamental difference between a situation in which a decision maker is uncertain about the state of X and a situation in which the decision maker has not given any thought to whether X matters or not, between a situation in which a prethought event judged of low probability occurs and a situation in which something occurs that never has been thought about, between judging an action unlikely to succeed and never thinking about an action’ (Nelson and Winter, 1982, p. 67).

Based on this observation, alternative decision-making rules have been adopted to represent the micro-foundations of economic transactions. The evolutionary theory of economic change has developed a new framework of economic analysis based on the notion of routines as decision rules. It corresponds to all regular and predictable behavioural patterns of the firms.¹³ Thus, this approach argues that firms use routines to simplify their decision procedures, taking into account their capability and the objective of making profits. An established routine is not related to the goal of profit maximisation, but rather to the achievement of satisfactory results. Firms try to adapt their decision routines to ensure a satisfactory profit level in comparison with their competitors.¹⁴

A recent study on the functioning and organisation of the electric motor market in France¹⁵ revealed the presence of not only market failures but also market limits¹⁶ which prevent consumers from making the best decisions with respect to energy efficiency. This study provides valuable information for analysing the question of appropriate policy for effective market transformation towards energy efficiency. Through an analysis of the structure and functioning of the electric motor market in France, the present paper tries to distinguish market failures from market limits. The paper claims that market failures cannot always explain the extent to which energy efficiency is taken into account by agents in electric motor transactions. Thus, effective market transformation activities should take into consideration the market limits.

The present paper is organised as follows. First, the potential for energy conservation through the diffusion of HEM technology is assessed in order to identify the efficiency gap in the electric motor market. The structure and functioning of the electric motor market is then analysed, with an examination of the decision-making practices of the main actors in each market segment. Finally, the paper attempts to provide a comprehensive view of the market failures and limits for the diffusion of HEM technology in order to understand some of the initiatives which could lead to market transformation.