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Energy EfficiencyLessons from the Past and Strategies for the Future

Lee Schipper

In the next century, strategies to encourage energy efficiency could moderateenvironmental problems while saving energy, in spite of the enornous potentialfor growth in the world demand for energy. After describing the energy prob-lem, this paper reviews trends in energy use and energy intensities in the 1970sand 1 980s in the industrial countries, the former planned economies of EasternEurope and the U.S.S.R., and the developing countries. Lessons from thoseyears are used to frame policies that could improve levels of efficiency in all thesecountries. Estimates offuture prospects for more efficient energy use in the year2010 under various scenarios show the possibilitiesforfurtber improvement.

he world is not running out of energy, John Holdren has asserted,' nor isit running out of techniques for transforming energy resources into theforms we need. What is running out, Holdren maintains in his prologue

to Schipper and others (1992a), is what permitted the growth of material wealthin today's industrial nations and led us to expect a similar path to prosperity fortoday's developing countries-the ability to expand the supply of energy at lowdirect cost. Holdren concludes his discussion with a scenario for energy use in2025, when total world use of primary energy is projected to increase to nearly600 exajoules, from 410 exajoules today. (See table 1 for an explanation oftechnical terms.) However modest this increase seems, it depends on optimisticassumptions about the growth of population and income per capita in poor

Lee Schipper is staff senior sientist with the Internazional Energy Studies Group at Lawrence BerkeleyLaboratory. He is associated with the Stockholm Environment Instiute, which supported two earlierworks on which this paper draws heavily (Schipper and others 1992a, b). The author would like to thankSteve Meyes for his invaluable contribution, as well as Lynn Price and Ted Garmer, who providededitorial assistance, and Dennis Anderson, who made helpful comnuents.

Proceedings of the 'World Bank Annual Conference on Devlopment Economics 1993© 1994 The International Bank for Reconstruction and Development / MIEWXo: BANww 397

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Table 1. Defintions,of Energy Measurements and Terms

* 1'jouic(uJisrt1ibaeiactni of energy in the System Intemationale. There are 4.1'7 joues in acalorie, which is the energy required to heai I gram of water I degree C.

1 exajoule (EJ) is lOIR joules; 1 petajoule (PJ) is I0s joules, and 1 gigajoule (GJ) is lO joules.

Primary energy: all energy consumed, including losses at various stages of energy harvesting andprocessing

Delivered orfinal energy: heat content of energy consumed at a factory or building or in a vehicle

Useful energy: final energy minus estimated conversion losses at the site of final use

countries and about the prospects for herculean improvements in energy effi-ciency. By 2050 Holdren's world requires 860 exajoules of primary energy.

No serious analyst doubts that a slow expansion of world energy marketscould provide 600 exajoules of primary eneLgy by 2025. What Holdren worriesabout is not just whether the use of that much energy is affordable but alsowhether the environment and climate can bear it. Many of the largest energyusers today (China, India, Russia, and, in many ways, the United States) haveignored the environmental costs to health and productivity from air and waterpoullution and soil erosion or have avoided internalizing them. Holdren's justifia-ble concern is the reason for this paper.

Until recently, apprehension about the economic and political costs of inter-ruptions in the supply of oil dominated energy policies. Now, however, theshare of oil in primary energy supplies has diminished, and various schemes forstoring oil or substituting other energy sources are in place. Since concerns aboutinterruptions are no longer as urgent as they were twenty years ago, placing avalue on energy security will not be central to the argument here.

For the next several decades the supply of liquid and gaseous hydrocarbon isexpected to expand slowly at prices that will not rise faster than the rate ofeconomic growth. The cost of this "moderate" growth in oil prices may nev-ertheless place a significant burden on the economies of developing countriesbecause the real price of oil will be higher than when the Western economieswere growing in the 1950s and 1960s and because the developing countriesalready face difficulties ill financing expanding energy supplies. When the drainon foreign currency to import oil today is coupled with "second-beste (at most)energy pricing, most of the non-oil-exporting developing world faces manydifficulties in expanding energy supplies.2 Adding environmental costs to thosedifficulties makes the situation even more precarious.

Real uncertainties face the centrally planned and former centrally plannedeconomies. China's hopes are pinned on doubling its use of energy, mostly fromcoal, while quadrupling its economic activity. Whether such hopes are realisticfor a planned economy is questionable; certainly the former planned econ-omies of Eastern Europe have run into enormous difficulties in the energy

398 Energy Efficiency

sector. Their state-run energy systems, many of which are still based on totalyunrealistic energy prices and burdened by overemployment, must somehow betransformed, through the opening of markets, into efficient economic enter-prises. Recent studies of the former U.S.S.R. (Schipper and Martinot 1993a, b)and Poland (Meyers, Schipper, and Salay forthcoming) show that the disrup-tions caused by the fall of communism will shake the energy sectors of theformer planned economies for many years to come. These countries are oftenreferred to as "economies in transition," but the word "transition" implies asmooth change. In Eastern Europe the changes in the energy sector are abrupt,the supply options in the near- and medium-term are grim, and the situation issaved mainly by the rapid collapse of economic activity.

The populations of the former planned economies and of many developingcountries are imperiled by the high level of emissions from the production anduse of energy. Although the benefits of using energy are presumably greater thanthe costs of pollution, the residuals are large. This message emerged clearly fromthe "Earth Summif" in Rio deJaneiro in 1992.

Nevertheless, developing countries have been reluctant to internalize the sig-nificant environmental costs to health and productivity related to producing andusing energy. Many representatives from these countries at Rio and at othermeetings have suggested that the environment is an industrial country problem(see Nazer 1993) and that the developing world has more immediate concerns.Many of the large cities of Latin America and Asia that had ignored air pollutionproblems caused by the automobile are now beginning the struggle to reducepollution by cleaning up emissions from burned fuels and improving the vehiclesand boilers that spew out pollution. But traffic gets worse everywhere. Clearly adean environment, however desirable and important, will not come free ofcharge.

In Eastern Europe lower industrial production has slightly reduced pollutionfrom factories and from the convs. kmr and consumption of energy. But in theCzech Republic, Hungary, anD Poland a surge in the popularity of private cars,mostly using unleaded fuel, has raised air pollution in the cities. Coal-basedpower systems continue to disgorge pollution in Slovakia, Bohemia, and, per-haps worst of all, Silesia, where many small coat burners and stoves heat homesand buildings. Particularly unsetding is the future of the Soviet-designed RBmK(Chemobyl-type) or vVER (Soviet-style pressurized water) nuclear reactors stillin use in Bulgaria, the former Czechosliovakia, Lithuania, Russia, and theUkraine. Is one of these the next CGehaobyl, as a speaker from the World Bankwondered at the World Energy Congress in Madrid in 1992?

Possibly the greatest long-run environmental threat to all countries is carbondioxide emissions from the use of fossil fuels-the dominant component ofanthropogenic greenhouse gases. Many agree that it will be years or decadesbefore unambiguous signs of problems appear. Whatever the ultimate change intemperature and the subsequent damage to both ecosystems and economies (seeCline 1992a, b, and Howarth and Monahan 1992), there does appear to be a

Scbipper 399

scientific consensus about the presence of an anthropogenic temperatureincrease traceable to these emissions (ipcc 1992). The industrial countries arecertainly aware of this problem, and some have moved to internalize at leastsome of the risks through modest carbon taxes, but the formerly planned econ-omies and the developing countries are suspicious and are preoccupied by otherconcerns. This means that a serious response may be delayed for years.

Moderating the demand for energy reduces all the problems just described andcontributes to their solution. A shift in the demand curve for energy through thediscovery and development of new technology (or the increased use of oldtechnology) means that society uses less energy and creates less pollution forgiven levels of gross domestic product (GDP) and energy prices. It could beargued that whenever energy efficiency rises, individual and societal welfare isincreased. This is not to say that energy efficiency is a good in itself. But energyefficiency, as defined in this paper, means improving economic efficiency byimproving the technical efficiency of energy use; that is, decreasing the ratio ofenergy consumed to output produced. Strategies that increase energy efficiencyincrease our welfare too. Since GDP grows when total factor productivityincreases, energy efficiency is good for the individual and good for the economy.

Market forces are the most important vehicle for allocating energy and otherresources. Hence they are key to improving the efficiency of energy use andthereby restraining the growth of future energy demand. In some sectors, unfor-tunately, market failures, frictions, or time lags weaken market forces or inhibitthem froLi transmitting information to energy users. A few strategies that gov-enrments should adopt to boost energy efficiency are suggested below.

Energy Use and Energy Intensities

In most discussions of energy efficiency, energy saving, or energy conservation,reduction in energy intensities is the goal. Energy intensity-the amount ofenergy used per unit of activity-is the inverse of efficiency. The energy inten-sities of individual activities depend on how equipment is designed, operated,and maintained and how well capacity is utilized, as well as on the type ofenergy used. (Much of this section is condensed from Schipper and others1992a, b.)

Between 1970 and 1990 energy use grew, on average, only 1.3 percent in theindustrial countries and 2.4 percent in the former planned economies but 4.5percent in the developing countries. These countries' share of the world totalwas 31 percent in 1990, when biomass fuels (plant material or agriculturalwaste used as an energy source) are included. Changes in the levels of differentactivities raised energy use in all three regions; changes in the mix of activitieshad only small effects in the industrial and forrner planned economies butboosted energy use in the developing countries. All else being equal, changes insubsectoral energy intensities alone reduced energy use in the industrial coun-

400 Energy Efficiency

tries by almost 20 percent but had very little effect in Eastern Europe and only asmall downward effect in the developing countries, particularly China.

The Industrial Countries

The analysis in this section is based primarily on nine members of the Organiza-don for Economic Cooperation and Development (oEca)-Denmark, France,the former Federal Republic of Germany (FRO), Italy, Japan, Norway, Sweden,the United Kingdom, and the United States. This group, referred to here as the"oECD-9, accounts for 85 percent of final energy use in the osc.

Final energy use per capita declined 15 percent in the United States between1973 and 1988, but it rose 10 percent in Denmark, Germany, and Sweden and46 percent in Japan. Increases in the market share of electricity pushed downfinal energy use in all cases. In the oEcD-9 countries, energy intensities for suchkey activities as driving, heating and cooling, and industrial production fellnearly 20 percent. In 1988 home energy accounted for about 20 percent of finaienergy use in five industrial countries-Denmark, Germany, Japan, Sweden,and the United States (see Howarth, Schippa, and Anderson 1992).

In the industrial countries the service sector accounted for 11 percent of finalenergy use but for a higher share of primary energy because of the importance ofelectricity in this sector. Between 1973 and 1988 use of energy for services grewat an average annual rate of 0.8 percent in the United States and WesternEurope but by 3.9 percent in Japan. In each case the rise in energy use was muchless than the increase in the value added in the service sector. Aggregate intensitydeclined 28 percent in the United States and Europe and 15 percent in Japan.Fuel intensity declined 36-43 percent, but electricity intensity increased 28 pr r-cent in Europe, 36 percent in Japan, and 15 percent in the United States.

Energy use for domestic travel accounted for about 22 percent of final energyuse in the industrial countries; of this, automobiles accounted for nearly 90percent. Total domestic travel, measured as passenger-kilometers, grew byabout 40 percent between 1973 and 1988 in Europe, Japan, and the UnitedStates. The energy intensity of total travel (energy use per passenger-kilometer)increased slightly in Europe and substantially in Japan but declined 18 percent inthe United States. Because the United States accoutnts for 70 percent of totalOECD-9 energy used in travel, this dedine caused a 13 percent drop in OECD-9travel energy intensity. Structural change played a small role in increasing aggre-gate intensity in the United States and Europe, but it had a major effect in Japan,where automobile use rose considerably in the 1980s.3 Adjusted for strucuralchange, the energy intensity of travel rose slightly in Europe and Japan butdeclined 15 percent in the United States. Auto-vehicle energy intensity fell 30percent in the United States, in spite of the increasing number of light trucks inthe personal fleet (light trucks use more energy per kilometer than cars). Therewas little change in Europe and Japan, which began the period well below theUnited States. The number of people in a car declined in the oEcD-9, offsetting

Schipper 401

much or all of the reduction in auto-vehide intensity, so that energy use dedinedless in the United States and rose slightly in Japan and Europe. The energyintensity of air travel declined about 50 percent, which contributed to thedecrease in the aggregate energy intensity of travel.

Freight transport accounted for only half as much energy use as travel in theindustrial countries (about 10 percent). Energy use for domestic freight trans-port in the OEcD-9 increased at an average rate of 2.3 percent a year between1973 and 1988, somewhat faster than the annual increase in tonne-kilometers.The increase in aggregate intensity was higher in Europe and Japan than in theUnited States because of structural change toward greater use of trucks, espe-cially in Japan. More important, the energy intensity of freight trucking, whichaccounted for 85 percent of total freight energy use (excluding pipelines),increased about 13 percent in the United States between 1973 and 1988,declined 16 percent in Japan, and remained about the same in Europe as a resultof a shift toward smaler trucks and smaller loads in larger trucks.

The share of manufacturing in OECD-9 final energy use declined from -36percent in 1973 to 27 percent in 1988. For eight OECD countries (referred to hereas the oEcD-8; Italy was omitted because of disaggregation problems), manufac-turing value added rose 2.3 percent a year between 1973 and 1988, while energyuse fell 1.2 percent and aggregate manufacturing energy intensity fell 40 percent.Strucural change away from energy-intensive industnes accounted for about afourth of this decrease in aggregate intensity. Holding the structure of manufac-turing in the oEcD-8 constant at 1973 production values, manufacturing energyintensity declined 32 percent (Howarth and others 1991).

The overall impact of change in activity, structure, and energy intensities wasassessed by analyzing the three largest industi economies-Japan, the UnitedStates, and the FRc-as well as three smaller countries, Denmark, Norway, andSweden. The impact of growth in sectoral actiity levels alone increased priwaryenergy use in all countries and by as much as 54 percent in Japan between 1973and 1988. The effect of structural change within sectczs raised primary energy usein all countries-up to 22 percent in Norway. Changing energy intensities reducedprimary energy use in all countries, from as much as 22 pernt in Denmark to 4percent in Norway. In the countries with the deepest savings (Denmark, the FRG,and the United States) almost all sectoral intensities declined, while in the remain-ing countries, including Japan, two or more sectors experienced increases inenergy intensities. Not surprisingly, savings were greatest in countries where theincrease in energy prices was sharpest In most of these countries the ratio ofenergy use to GDP declined more than did energy intensities, suggesting that thisratio is an inappropnate way of measuring energy efficiency or its evolution.

The Former Planned Economies

Primary energy use in the economies of Eastern Europe, dominated by theU.S.S.R., increased only 2.2 percent a year in the 1980s, down from 4.4 percent

402 Energycency

in the 1970s. Although activity increased in all sectors in the former plannedeconomies, in most cases the increase was much smaller than in the industrialcountries. Structural change had a modest effect on energy use, but the contrac-tion in heavy industry was more than offset by increases in housing and inpersonal transport Since 1989 structural changes in Poland have dramaticallyreduced industrial energy use, although again some of this decline was offset byincreases in automobile fuel consumption (Meyers, Schipper, and Salay forth-coming). But heavy industry and freight still dominate energy use in these coun-tries, in contrast to the industrial countries, where homes, services, and traveldominate.

The behavior of energy intensities was mixed. Some intensities in heavy man-ufacturing and air travel declined. The intensity of space heating in homesdeclined slightly in the U.S.S.R. Overall, the improvement in energy efficiency inthese economies was small compared with that in the West. Given the lack ofprice or competitive incentives for improvement, this is hardly surprising.

The Developing Countries

Primary energy use in the developing countries increased more than twofold!setween 1970 and 1990, accelerating after 1982.4 In general, activity levels rosefaster in Asia, the Middle East, and North Africa than in Latin America andSub-Saharan Africa, although per capita activity remained higher in Latin Amer-ica. Growth in manufacturing output was especially rapid in Asia. In all sectorsstructural change contributed to the increase in energy use. For most countriesthese changes were so significant as to dominate the changes in the ratio ofenergy use to GDP.

Energy intensities in developing countries fell somewhat between 1973 and1988, driven by the introduction of modern manufacturing processes, new elec-trical equipment, and somewhat more efficient vehicles. In homes the energyintensity of cooking declined because of the shift away from biofuels, and therewere signs of improvement in the efficiency of appliances. These modest gains,however, were swamped by other factors that increased the use of energy.

Lessonsfrom Historical Analysis

What caused the drop in energy intensities in the industrial countries? Theanalysis on which this paper is based found that as much as 80 percent of thedecrease can be attributed to technological changes in equipment between 1973and 1988. The remainder is traceable to more careful consumer behavior andbetter management of factories and buildings. In Poland and the U.S.S.R. therewas little evidene of significant improvement in energy efficiency as a result oftechnological change through the late 1980s. In developing countries theimprovements in industrial production, commercial buildings, household cook-

Schipper 403

ing, and household appliances were apparently achieved through acquisition ofnew technology. The declines in energy use that occurred whenever fuel pricesrose were behavioral and faded as prices fell.

In manufacturing in the industrial countries and in air travel worldwide, thereductions in intensity were in part the result of long-term technological changesthat were accelerated, but not initiated, by higher oil and energy prices after1973. By contrast, before the oil price shocks the energy intensities of auto-mobiles, space heaters, and household appliances were stable or, frequently,rising. The often dramatic reversals that occurred after 1973 were dearly drivenby higher prices and, in some cases, by energy-efficiency policies.

The declines in energy int' asities can therefore be attributed to three importantfactors. Higher rnergy prices caused the greatest decline in energy intensities, evenif we discount the change already occurring before 1973, and led to some restraintin the levels of activities and in sectoral structure within energy-intensive manufac-turing anc1 travel. Long-term technological change reduced energy intensities inindustry and air travel relatively independently of energy prices. And energy-conservation programs had some impact, beyond the effeac of price changes.

In general, large changes in prices, as in the case of oil in 1973-74 and 1979-80, provoked a significant and permanent response; smaller changes werequicldy undone by inflation. This is especially true of ansport fuels.

Most governments in the industrial countries instituted energy-efficiency poli-des arid programs in the 1970s and 1980s, although the nature and extentof these efforts varied considerably (IEA 1992). Since the 1980s many electricutilities in the United States and, to a much lesser extent, in Western Europehave implemented programs to encourage electricity conservation by their cus-tomers. Efforts by govrmnents and utilities to accelerate improvements in effi-ciency have been aimed mainly at the residential and service sectors. In WesternEurope and Japan automobiles escaped the attention they received in the UnitedStates, although manufacturers and governnents did agree to improve the fuelefficiency of cars. Few countries developed programs that had much effect onmanufacturing, freight transport, or air travel. Various programs for promotingenergy conservation are summarized here, with estimates of their impact.

- Extensive dissemination of information and propaganda to promote energyconservation, including labeling oif vehicles and appliances and training foremployees. The impact is difficult to assess.

* Imposition of efficienqc standards for new structures in Europe and manyU.S. states; for electrical appliances in some U.S. states (in all states after1990) and, soon, in some countries in Europe; and for automobiles in theUnited States. The strongest impact is on energy use of new equipment.

* Voluntary agreements between the government and domestic manufacturersin Japan and the FRG for improvements in major household appliances. TheGerman agreement forced manufacurers in other European countries toimprove efficiencies in order to stay competitive in the FRG.

404 EneTy Efficency

• Introduction of substantial new energy taxes on certain fuels by Denmark,France, Italy, Norway, and Sweden. This step accounted for the greatestdeclines in energy intensities among the policies listed here. (Meanwhile, theUnited Kingdom effectively subsidized household energy by exempting itfrom value added taxes until 1993.)

* Subsidies (grants and tax credits) for retrofits of existing homes and, insome cases, for new buildings. These measures had some effect on energyefficiency-although the impact of free riders is uncertain-and provided animportant demonstration that retrofits could indeed lower energy bilis.(This is the "free-driver" effect; early adopters who take advantage of theseincentives convince others that the savings are real and worthwhile.) Whenthe probable savings from retrofit programs are compared with savingsfrom all factors, subsidy programs probably accounted, directly or indi-rectly, for no more than 20 percent of the redluction in space-heating inten-sity in existing homes in North America and Western Europe.

To estimate the overall imnpact of these programs, for each end-use the changein energy intensity between 1973 and 1987 that was judged to have beeninduced by policy was multiplied by the corresponding level of activity for thatend-use in 1987. The sum of the estimated policy impacts indicated that pro-grams alone were responsible for about one-eighth of the total energy savedthrough intensity reductions in the- industrial countries between 1972 and 1985(see Schipper 1987). Policies aimed at builders or equipment manufacturerswere generally more effective than those aimed at smal consumers.

Were efficiency programs effective? Some economists maintain that con-sumers are the best judges of how to allocate their resources. An efficiencystandard, they say, only forces undesired change on consumers (or producers ofconsumer goods), and a subsidy or incentive program encourages consumers tomake investments from which they derive no personal benefit, since otherwisethye would have made the investments without subsidies. The proponents of thepolicies point out, persuasively, that consumers have virtually no advanceopportunity to measure the efficiency implications of their choice of homes,refrigerators, or cars and are rarely presented with side-by-side choices in whichthe only difference is in energy-conservation technology. These problems lead toinformation-related market failures. (The case that car buyers have poor infor-mation about fuel use is harder to make. As for users of industrial energy, onemight ask whether factory managers who cannot estimate potential energy usesand savings are good managers in the first place.)

The Plateau of Energy Efficiency and the Near-Term Outlook

When the price of oil coflapsed in 1985, not all end-user energy prices fell, butmany stopped rising in real terms. Since then, energy efficiency has increased

Schipper 405

more slowly or has stayed level, and energy prices have flattened or fallen.Although new technologies or replacements for worn equipment are still gener-ally less energy-intensive, the pressure to replace equipment because of its highenergy consumption has abated. When replacement or expansion occurs, thereis less interest in which technologies use the least energy.

Some effects of the plateau are obvious. In the United States the energyintensity of new cars and light trucks has moved upward slightly as the share oflight trucks has grown, but it still lies below the average for the fleec. Indoortemperatures have inched upward, but they are still below their 1973 values.Insulation is not being removed from homes, industrial equipment has notbecome less efficient, and no airlines have traded their new Boeing and Airbusequipment for old Boeing 707s, Comets, or Caravelles. Knowledge gained andtechnology developed during the 1970s and 1980s will not fade away because. oflower energy prices. Thus energy intensities wlll continue to decline for sometime to come.

During the 1950s, 1960s, and early 1970s industrial energy intensities fellwhile energy prices were falling. What offset the decline in intensities and insome cases raised the ratio of energy to total GDP was the rapid increase in thenumbers of cars, homes, and equipment (induding central heating), in the own-ership of electric appliances, and in the electrification of commercial buildings.Clearly, an important determinant of the future energy intensity of the industrialeconomies will be the level of travel by car and air and the total volume in theresidential and service sectors that is heated. Equipment that provides mobilityand comfort has, for the most part, reached the saturation point in NorthAmerica and the wealthy countries of Europe. Only in Japan and southernEurope is there still considerable room for growth in stocks of such equipment.Thus the slowdown or plateau in energy efficiency will not stop a slow decline indie ratio of energy use tO GDP in the industrial countries.

Recent trends will affect the former planned economies and the developingcountries. Equipment appearing on the market in these countries today reflectstechnologies introduced in the industrial countries several years ago. Manydeveloping countries are themselves becoming manufacturing centers for keyconsumer technologies, motors, and other devices that are marketed in theindustrial countries. As industries in developing countries face more open mar-kets, with fewer subsidies and less protection, they will be forced' to streamline,modemize, and cut costs, including energy costs. In some developing countries,such as the Republic of Korea, many industries appear to be in the vanguard ofenergy-efficient technology. Thus the wave of efficiency from the 1980s is stillcoming ashore in the formerly planned economies and the developing countries.

Barriers to Efficient Use of Energy

The "energy consenration paradox" (described by Shama 1983 and elaboratedby Jaffe and Stavins 1993a, b) is that consumers appear to underinvest in

406 Eneigy Efficiency

energy-efficient technology. A study of the 1970 U.S. housing stock (Moyers1973; Schipper 1976) revealed that by increasing insulation, virtually all home-owners could have reduced heating losses 20 to 40 percent, saving money evenat a time when energy prices were at their lowest point of the century in realterms. Jaffe and Stavins ascribe this paradox partly to poor diffusion of newtechnologies, but poor insulation was as much the result of too little conven-tional insulation as of delayed adoption of new technology such as double- ortriple-glazed windows (Moyers 1973). The difference between what appears tobe optimal and what consumers actually purchase can be called the "efficiencygap."

It is difficult to discern a major efficiency gap in industry or commercial airtravel. Managers and engineers in competitive firms continually evaluate energyefficiency and other cost-reducing or output-maximizing options in the light ofsuch constraints as the cost of capital, the attractiveness of competing invest-ments, scheduling of maintenance or repairs, and the ability of staff to masternew technologies. This process works fairly well for manufacturing: the ratio ofindustrial energy consumption to output in the major industrial countries hasdecreased since World War II, even as real energy prices fell.

The same general trend is seen in commercial air travel, although the switchfrom propeller to jet aircraft brought a one-time increase in energy intensity inthe late 1960s. Because a liter of fuel saved makes 900 grams of payload avail-able for sale, the decline in fuel intensity for aircraft has been enormous. Thusfirms that use energy as an input appear to respond to opportunities to reducetheir energy costs.

Energy costs for running commercial buildings are usually very small inrelation to the cost of the property and other operating costs and are hence nota major competitive factor. However, the total energy bills for a property canbe quite large in relation to the cost of the time a "building engineer" wouldspend improving system performance. The presence of renters and a diversemix of physical and economic activities complicates the situation. Tenantscannot always choose to save energy, even if they pay their own energy bills.Very often the heating, cooling, and ventilation systems are collective, notindividual.

Why does the efficiency gap arise for consumers in industrial countries? Themost obvious reason is that they have poor information. More important, theycannot process the information they do receive. They cannot measure energy useover time, make present-value calculations, and choose from alternative invest-ments in energy-saving technologies. Even evaluating equipment from amongclearly labeled options is time consuming. There is no engineer to monitorenergy-using processes. The small scale of energy use in homes and equipmentmakes it almost impossible for householders to deal individually with thesechallenges. Needless to say, the opportunities for consumers in the formerlyplanned economies and the developing countries to make such choices are vir-tually nil because of lack of information and poor selection.

&hiprtper 407

Worse, consumers almost never see a choice of energy technologies, and otheraspects of the equipment are more important to them. Generally, the producersof equipment or the owncrs of buildings choose the technical options. Someappliances, such as water heaters, air conditioners, freezers, and furnaces, pre-sent a few options, but those appliances are often installed bey builders or boughtby consumers in haste when an old model breaks down. Only for the very smallnumber of consumers who hire architccts to design their homes can the thermalcharacteristics of the home and the energy properties of appliances be chosen inadvance.

Producers of consumer goods find it difficult or impossible to demonstrate toconsumers the economic benefits of investment in efficient or new technology.Consumers cannot measure the results and so are unlikcly to believe the claimsof producers. For this reason, new technology is adopted very slowly until acertain market penetration is reached, after which adoption moves quickly. As aresult, producers have little incentive to improve their products if improvementwill require a perceptible price rise.

Rental housing presents a special problem. It is difficult to divide up invest-ments in efficiency and allocate the savings between owners and renters. Iftenants' utilities and heating are not metered, as is often the case, incentives tosave are low. Not surprisingly, energy use per capita or per square meter inunmetered apartment buildings is almost always higher than in buildings withmeters in each apartment.

A convenient, although imperfect, way of characterizing the adoption of tech-fiology by consumers is to estimate the implied consumer discount rates at whichthe options installed are the lowest-cost choices. Typically, these rates are veryhigh. This may be because of the risks consumers face concerning future energyprices, real paybacks, and credit problems, in addition to the extent to whichthey value current over future income. The high discount rates are not them-selves a market failure (although market failures help explain them), but theysuggest significant barriers to additional investments in efficiency and in newtechnologies.

These considerations lead to an important conclusion: energy-efficiency policiesare justifiable when experience shows that market failures or other barriers areleading to energy consumption that could be efficiently corrected by adopting newor existing technology. The policy criterion must be economic efficiency, notsimply reduced energy intensity. In our zeal to promote energy efficiency, we mustnot develop policies that incur other, hidden, costs. Not all market failures can becorrected, not all frictions oiled, and not all barriers set aside.

Policy interventions to encourage more eronomic allocation -of resourcesshould be nonintrusive, focusing on narrow technological tradeoffs rather thansweeping changes that affect product features. If aimed at consumers, theyshould address the few energy uses or types of equipment for which energy costsdominate costs over the life of the equipment-heating, cooling, water heating,refrigeration, and possibly cooking and lighting.

408 Energy Efficiency

The Sectoral Approach to Energy Efficiency

The slowdown in the decline in energy intensities in the industrial countriessuggests that improvements in efficiency have run their course there, at least atpresent levels of energy prices. Can authorities devise policies that wili encour-age greater energy efficiency? One promising avenue is the sectoral approach, inwhich initiatives for improving energy use are embedded in policies aimed atimproving the productivity of resources within a sector. The policies are exe-cuted by the public authorities representing the sector; by authorities in electric,gas, or heat utilities; and by the enterprises that operate the sector'sinfrastructure.

The Industrial Countries

BUILDINGS, APPLIANCES, AND EQUIPMENT. In the case of energy uses for house-holds and commercial buildings, the "sector" is distributed over millions ofindividual households and buildings. It is convenient to classify as "upstreamn"those policies that affect primarily the manufacturers of energy-using equip-ment, including builders; as "midstreamr those policies carried out by interestedthird parties (utilities and city or other local authorities); and as "downstream"policies directed at purchasers of equipment and energy users.

Efficiency standards for appliances, an upstream strategy, are among the mosteffiective policies to date. First promulgated by individual U.S states and, as of1990, by the U.S. government, they are now spreading to Europe. Thermalstandards for new housing have also accelerated the adoption of technology. Themost successful application has been in Sweden, where the imposition of stan-dards is linked to construction financing and is carried out in dlose cooperationwith thc building and equipment industries (Schipper, Meyers, and Kelly 1985).This is a good example of a sectoral policy because energy efficiency in housingand buildings is treated as an aspect of comfort and affordability in housing.

Innovative procurement is a complementary strategy for stimulating improve-ments in equipment. Where no single manufacturer will risk applying new tech-nology or a new approach to a piece of equipment, the govermment sponsors acompetition to cee if manufacturers can meet particularly advanced energy-efficiency standards for certain equipment without losing consumer acceptance.The government also organizes buyers (in the Swedish case, large housing-cooperative buyers of refrigerators; retail chains are another possibility). Orga-nizing buyers is import.st if the market is dominated by individual small con-sumers or by relatively small builders or other buyers. The government, ratherthan doing the research and development (R&D) itself and hoping that privateproducers will adopt the new technology, assumes some of the risk that equip-ment producers run in being first with the necessary R8&D. The government alsoplays an important role in organizing objective tests of the equipment Innova-tive procurement now includes competition for self-extinguishing computer

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screens and for low-energy laundromats and laundry rooms in multifamilydwellings. It, too, is an example of a sectoral policy because it is aimed at thevery process of innovation, production, and market penetration.

Midstream strategies rely on economic incentives designed to encourageequipment retailers and builders to invest in conservation. In the 1970s thesetook the form of subsidies offered by utilities to b-ilders and appliance distribu-tors who offered energy-efficient options in new homes and equipment.

"Green Lights," a program developed by the U.S. Enviromnental ProtectionAgency (see Kwartin 1992), examined the lighting bills of large enterprises andfound that many of these enterprises were willing to shift to newer, more effi-cient lighting systems. More recently, the Environmental Protection Agency hasmoved Green Lights upstream. -Noting the enormous increase in electricityneeded both for running computers and for cooling buildings with many heat-emitting computers, it began working with the manufacturers of computers andcomputer screens to find ways of reducing the energy used by these applications.Because Green Lights is aimed at large energy users, it can work with firms thatown or administer substantial office or institutional space. In this sense, GreenLights is an indirect sectoral policy that aims at the largest participants in asector, creating a market for new technology in that sector.

One downstream strategy is to try to reach consumers with real informationthat includes specific measurements, not simply labels telling them what theymight save on average. Obviously, information is vital, but it is not clear that byitself information significantly raises participation or investment. As notedabove, the main difficulty with the information strategy is that it must reachmany small activities and millions of individuals.

Another downstream strategy targets consumers through financing and otherincentive schemes. The record is mixed (Schipper and others 1992a, b); it isclouded by problems with free riders, adminimstrative costs, and lack of clearbefore-after and control-group data for measuring the results (although follow-up studies do indicate modest success). Left out of the analysis is the "free-driver" effect mentioned earlier.

The most significant experiment in downstream programs in the past fiveyears uses "integrated resource planning" and the related Idemaid-side manage-ment." Through integrated resource planning, utilities integrate demand reduc-tion into their planning when it is cheaper than supply expansion. Demand-sidemanagement refers to the actual process of selling the technologies or othermeans of reducing demand. Currently, many U.S. utlities are spending largesums to test this approach, with some preliminary favorable results (Nadel1992). Some of these efforts are aimed at stores and builders, which could beregarded as a midstream strategy; in addition, a coalition of utilities has spon-sored a competition to produce a very efficient refrigerator-an upstream strat-egy. Much controversy surrounds both the theoretical underpinnings (see Jos-kow and Marron 1993) and the practical questions of real results andadministrative costs Joskow and Marron 1992).

410 Enay Efficiency

Less effort has gone into stimulating efficiency improvements in new service-sector buildings and equipment. Few efficiency measures can be imposed oncommercial buildings because of the complexity of large structures and themultitude of energy uses (and users) in them. In most industrial countries (andmany U.S. states or smaller regions) standards apply only to the outer shells ofcommercial buildings, although the 1992 U.S. National Energy Policy Act willaffect certain lighting systems.

Given the complexity of this sector, efficiency policies for commercial build-ings should focus on (a) upstream technology development and demonstrationsuch as Green Lights, in cooperation with builders and developers, and (b)retrofit support programs, particularly for financially beleaguered publicauthorities that operate schools, hospitals, and their own buildings. (Few publicauthorities are penmitted to consider future operating costs when decidingwhether to make current investments for energy efficiency-a particularly dis-turbing problem in developing countries such as Kenya and Indonesia.)

The Swedish experience suggests that teaching the financial community howto estimate energy costs and cost-reducing options during the planning andfinancing stages could lead to more carefully designed buildings. Unfortunately,most architects and engineers today are paid according to how much they designand how much equipment they assign, not how efficiently it works!

TRANSPORT. Fuel costs are small in relation to the cost of owning a car butlarge in relation to the cost of using it. At present, Western consumers arewillingly trading fuel economy for power, comfort, safety, and convenience.

One approach to combating such behavior is to emphasize the fuel efficiencyof vehicles. The problem is that there is no way to choose a fuel-saiing option inisolation. The only choice is between a fuel-saving option and a fuel-consumingfeature such as automatic transmission.5 Yet there is undoubtedly room forfurther fuel economies, both in the United States and elsewhere.

This problem has prompted calls for fuel-efficiency standards. Although theU.S. corporate average fuel economy (cAFn) standard- have undoubtedly had aprofound and positive effect on automotive technology in the United States, it isnot clear what measures might be implemented in the future. A wide variety ofmeasures have been suggested, induding limits on horsepower, new-car registra-tion fees that rise with the cars fuel intensity, and tightened CAFE standards.

Another possibility is to institute a government procurement program for carsor trucks. (By analogy, it might be called "Green Wheels.") In the first stage.govermnent buyers would actively seek out the lowest-fuel-intensity models ofthe size desired or, where practical, would buy smaller or less powerful vehicles.In the second stage governments might announce that over time they wereprepared to buy a given number of vehicles that satisfied certain efficiencycriteria.

The 1993 study of the American Academy of Arts and Sciences addressesmany transport problems: safety; air pollution; congestion; noise pollution;

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competing uses of urban space for parking, roads, and other purposes; access toservices for those too poor (or otherwise unable) to use cars; disposal of autohulks and motor oil; and problems specific to oil, such as energy security. It is nosimple task to rank all these problems or to put them in monetary terms.Attempts to address them would involve raising fuel prices (and taxes), imposingparking fees, and charging tolls for the use of certain roads during peak hours.

Proper implementation of these transport policies could lead not only to moreefficient vehides but also to significantly reduced congestion, air pollution, andtraffic. Since the efficiency of automobiles falls in congested traffic or on shorttrips, these changes should save surprising amounts of energy. Policies thatlower fuel intensity also lower the chief variable cost of driving, however, and itis important that this change not work against solving the other problems.6

By contrast, in aviation the high opportunity cost of wasting fuel means thatair carriers (and airframe producers) examine fuel costs dosely. Indeed, energyconsiderations prompted Boeing to begin work on its most energy-efficient air-plane, the 777. Elimination of regulated airfares and territorial restrictions onair traffic is another way to encourage better utilization and improve energyefficiency.

Sectoral policies are likely to be far more effective than fuel-efficiencr policiesalone in decreasing energy use in transport. In cities attention to congeston,pollutioTn, and the use of space could have a profound effect on automobiles andreduce the use of fuel Better utilization of trucks and aircraft would reduceenergy intensities and thus operating costs. Improved profitability in the truck-ing and airline industries would mean more rapid adoption of new vehicles thatare likely to use energy more efficiently.

MANUFACrURING. The record of uninterrupted energy savings in manufactur-ing shows that competent and competitive firms know their business and controltheir use of energy. Smaller firms, however, may do little about energy costs.They may not be able to afford much in-house expertise, or energy may repre-sent a modest fraction of their costs. Here energy-saving programs can be effec-tive. The electric or gas utility can "sell" energy-saving technologies (directly orthrough consultants) to small and medium-size energy users.

Sectoral policies go further, addressing the very nature of industrial technolo-gies and processes rather than simply focusing on energy saving. The Swedishprogram 'Teknik Upphandling," for example, aims at improving basic pro-cesses in ways that not only save energy but also strengthen other elements ofproduction. The point of collectve action is to boost productivity by increasingcollective knowledge about industrial processes through both laboratory R&Dand implementation in the real world.

The decline in energy intensities in Germany, Japan, and the United Statestends to be most rapid when growth is strongest. In part, this effect is related tothe business cycle. Intensities increase during recessions because capital is under-utilized and the trend toward more efficient processes slows. Recovery means

412 EneXr Effiiency

making up for lost time, and intensities often fall rapidly (Schurr 1982). Becauseof the link between strong growth in output and energy consumption, an indus-trial policy that promotes grwth and competition is a crucial ingredient inpromoting industrial energy enfi'ency.

The Former Planned Economies

The former planned economies .re different from the industrial countries forfundamental reasons. They have evolved under conditions of closed borders orprotective tariffs, the dominance of state industries, and subsidized and pollut-ing energy. They lack a peaceful democratic tradition or market orientation toguide energy and economic policymaking. Low incomes limit the sophisticationof consumers and their ability to make economic choices.

The level of technological know-how in former planned economies is so highthat it is tempting to cast the energy-efficiency problem in primarily technicalterms, but this would be shortsighted. Because energy pricing is unrealistic in allbut a few sectors, the main problems today are economic, not technological.Neither private nor viable competitive public firms have yet emerged in thesecountries. As the situation changes, enormous forces will be brought to bear torationalize the use of all the resources required to both improve the environmentand raise incomes.

Change entails major macroeconomic reforms, in-iuding the introduction of areal market for goods and services, expanded pri. ate ownership, and pricereform. It makes no sense to provide energy-efficient technologies to tenants orfactory managers who neither pay for their energy nor are responsible for thefinancial health of their enterpnses. To promote energy efficiency, policies mustbe designed to foster sectoral refoxrms.

BUILDINGS, APPLIANCES, AND EQUIPMENT. Privatization or decentralized publicownership of the housing stock should create a constituency of tenants andowners who will accept responsibility for energy efficiency. Taking a page fromthe Swedish system, financing for modernization of old buildings and construc-tion of new ones should be linked to thermal standards. This would entailmodest increases in housing costs, training programs for construction entrepre-neurs, and innovation and more effective marketing in the building materialsand equipment industry. A new generation of building materials and equipmentmust be developed to respond to these requirements. Heat meters should beinstalled in buildings or, preferably, in apartments, as should temperature sen-sors, thermostats, and shunts that allow both individual occupants and buildingmanagers to control energy use. Most important of all, there must be a move toa system in which the cost of energy depends on consumption, not on apartmentsize or number of occupants.

Commercial buildings in Eastern Europe should be built with modern energy-saving features for heating, cooling, and lighting, not only to save energy and

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reduce pollution but also to demonstrate the availability of these technologies.The appliance and equipment industry must be rehabilitated to make local firmscompetitive with Western firms. Western business interests, particularly thosefinancing hotels, restaurants, and office space, could be mobilized to import thetechnology or to stimulate local production. Training programs should be insti-tuted for local architects and engineers.

TRANSPORT. With the demise of coal-fueled locomotives, problems in this sec-tor come mainly from the jump in road transport, which has overburdenedroads and triggered a rapid rise in fuel consumption. Judging by the flood ofused cars from Western Europe now polluting the air in Poland, it appears thatPoles are willing to sacrifice fuel economy, comfort, and even safety for the sakeof personal mobility. In Western Europe the rapid growth in ownership of carsled to a decline in the use of public transit systems. Local authorities in EasternEurope must carefully weigh the effect of their housing, industrial, land-use, andtransport policies on the balance between private and public transport.

MANUFACTURING. In manufacnting the twin pressures of competition andprice reform will lead to improvements in energy efficiency. Plant managers havehad little experience with saving energy. They must learn about energy-savingtechnologies, how to deal with competitive equipment suppliers or outside engi-neering firms, and the dynamics of market-priced energy. Training by Westernor local authorities might help, but it would be more productive to focus on thenew technologies and methods of factory organization that should emerge in thenext few years. It might be sensible to concentrate on branch organizations-oreven the old ministries in such industries as steel, paper, and glass-rather thanon energy use itself.

The transition to a market system will require empowerment of authorities tometer and measure energy use in production facilities, improvement of the qual-ity of products with the help of better machines and higher tolerances, andacquisition of new equipment. Improvements in the use of energy are- not likelyto come any faster than improvements in the use of other resources. Eventhough energy is scarcer than other resources and the pollution associated withenergy is a pressing social problem, managers have to learn the tasks step bystep; they can leapfrog older energy-saving technologies but not the process oflearning why change is necessary.

AGRICULTURE. The end of state agriculture and the opening of borders toimported food mean enormous changes in agriculture. The former heavyreliance on fertilizer and inefficient tractors was energy-intensive and was notnecessarily productive. As reform continues, authorities should consider settingup a U.S.-style agricultural extension service that would provide -experts to helpfarmers modernize mechanized activities, irrigation, crop drying, and animalcare.

414 Eney Ef*ciency

The Developing CountriesThe achievements of Brazil, Korea, Singapore, and Taiwan (China) in grapplingwith energy efficiency are documented in Schipper and others (1992a) and thereferences there. Thailand and Tunisia have taken less heralded but successfulsteps toward energy efficiency. Even China has made much progress, althoughmany energy intensities there remain high (Levine, Lui, and Sinton 1992). Theseexperiences suggest that efficiency-related polices could be important in thefuture.

Opportunities for improved efficiency in developing countries are far greaterthan in industrial countries, for two important reasons. First, technologies areavailable that are far more efficient than those generally in use in the developingcountries or those that were available when the present industrial countries andthe formerly planned economies had the incomes of today's developing coun-tries. Second, manufacturing equipment and domestic infrastructure are grow-ing rapidly, offering far more opportunities for improving efficiency than inolder, stable economies or the formerly planned economies.

Poverty, the use of second-hand equipment, large rural populations withoutelectricity, and low levels of education have proved to be burdens that keepenergy efficiency in most developing countries at a much lower level than in theindustrial countries. Following the sectoral approach whenever possible, energy-efficiency policies should be directed to these serious problems rather than to thenarrow problem of energy inefficiency.

Many other problems plague energy use in developing countres. Voltagefluctuations often destroy or impair vital components of power systems. Tariffsand other trade barriers impede importation of even small energy-saving tech-nologies or components. Tariffs also discourage the manufacture of energy-efficient equipment such as appliances or motors on a large enough scale to beprofitable; in all but the largest countries the domestic market is too small, andproducts cannot easily be sold in neighboring countries. Protection of domesticindustries relieves pressures on managers to modernize and cut costs. And,finally, most developing countries suffer from energy-price distortions andrelated problems reminiscent of those in the formerly planned economies.

BUILDINGS, APPLIANCES, AND EQUIPMENT. Residential heating is not a problemin most developing countries. Improved thermal practices are already beingencouraged in China, Korea, other parts of Asia, and Latin America. Coolingwill consume increasing amounts of energy in virtually all developing countriesbecause of rising demand for protection against the summer heat and, in manycountries, year-round tropical climates. Financing for housing in the formalsector and improved building codes could be used to foster improvements.

The use of electric appliances, water heaters, and cooling equipment willcontinue to expand rapidly. Agreements with local manufacturers to adoptenergy-conservng features would restrain growth in home use of electricity atvery little incremental cost. Longer-lasting compact fluorescent lights could have

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an important additional impact by reducing early-evening demand for lighting,which boosts peak electricity loads and can mean that utilities incur significandyhigher marginal costs or must borrow in order to expand. Information should beformally disseminated, perhaps by the electric utility and local consumers' asso-ciations, to educate consumers about their options.

In Kenya a study found that multinational building owners had the mostknow-how and access to resources, although they did not always take steps tosave energy. To improve energy use in commercial and public buildings, thelocal utility could help implement the needed widespread education of localarchitects, engineers, and financiers so that they understand and embrace thetechnologies for reducing electricity demand. Loans from multilateral or bilat-eral authorities should be structured to encourage marginal investments in build-ing designs that reduce cooling and lighting needs and improve the efficiency ofmechanical and electrical equipment. The program developed by LawrenceBerkeley Laboratory for the AsEN region (Deringer and Busch 1992) offersmany good lessons.

TRANspoRT. Developing countries face an even bigger explosion in mobilitythan the former planned economies, as rising incomes combined with fallingtariffs make automobiles more available. The choices are the same as in theformerly planned economies. One is to allow automobiles and buses to prolif-erate unchecked and subsidized (to the extent that emissions are ignored) untilthe gridlock of Bangkok or Mexico City is reached. The other is to restraingrowing utilization of the road system by, for example, making drivers paydirectly through fuel taxes or tois in congested areas; taxing new cars that donot meet emission standards or that have large engines; and working withvehicle manufacturers to design new buses and smaller, more flexible transitsystems.

Developing countries face a particular dilemma. Although large countriessuch as Brazil, China, and India have at least a basic rail network and sometimesa well-developed one, smaller countries have only limited service along a fewcorridors or none at all. Service is not always reliable. As a result, freight willincreasingly be carried by trucks, often spurred by subsidies of diesel fuel thatfavor trucks over rail (Goldemberg and others 1987). Developing countries willhave to choose between investment in better rail lines and a major upgrading oftheir roads, many of which suffer from the enormous damage done by heavytrucking.

MANUFACTUING. The best ways of reducing energy use in manufag areto pursue energy-pricing policies that end -subsidies and to open borders so thatstate-of-the-art energy-saving technology can be imported instead of oil. Multi-national corporations usually have the most expertise in engineering, but localcompanies in lower-income and smaller developing countries also need access toengineering skills and engineers to improve existing production facilities. Thatwill require stepped-up university training.

416 Energy Efficiency

SUMmMARY. Sectoral policies should spearhead collective efforts to improveenergy use because so much structural growth or redevelopment will take placein the coming decades. Efficiency improvements can be linked to the enormousvolume of new capital that will be invested in developing countries.

The most important problem is the enormous growth in energy demandbrought about by economic growth of 3 to S percent a year over many decades.Whereas the economic decline currently being experienced by the fornerlyplanned economies has had the unlooked-for effect of relieving pressure on theirenergy systems, the most vibrant developing countries face a constant struggle toexpand their primary-energy production facilities, power systems, oil-refiningand distribution capacity, and gas networks. It is crucial that these systemsbecome increasingly self-financing through realistic marginal-cost energypricing.

Improved energy efficiency cannot stop the growth of energy use in develop-ing countries, but it might cut it in half. Moreover, restraining energy usethrough careful pricing of energy and transport could encourage travel by meansother than automobiles, spur urban expansion that permits closer access towork, services, and leisure activities, and discourage overexpansion of energy-intensive industries.

The energy-efficiency policies advocated here should follow certain guide-lines. Efficiency standards, if imposed, must be based on agreements with manu-facturers and producers. Incentives to consumers to conserve energy (such ashome audits, loans, discounts on efficient equipment, and demand-side manage-ment programs) should be demonstrably economic after a fair accounting oftransaction and administrative costs. The same is true for R&D incentives aimedat producers or builders. These approaches can- be combined with incentives forproducing market technologies that go beyond minimum requirements or for'developing new technologies. Most important, it must be understood that thesepolicies can complement pricing strategies but never replace them.

Future Prospects for More Efficient Energy UseEven when costs fall, new technology and knowledge continue to disclose moreefficient ways to use resources. Inprovements in energy efficiency have comeabout mainly through changes in technology that were induced not only byhigher energy prices in the short to medium term but also by technologicalimprovements in the medium to longer term. Thus efficiency might improveeven without sharp rises in energy prices, as occurred in manufacturing in mostindustial countries between 1950 and 1973.

That technology reduces energy needs in many ways can be illustrated by theproblem of heat loss from pipes in a food-processing factory. New pipes canreduce heat losses, and each investment in added insulation for pipes will furtherreduce losses, until the- last investment in insulation is equal to the discountedvalue of the heat saved (typically, near the level of the best new pipes). Or a new

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technology such as irradiation might lower the exposure to heat required forfood processing. Or the factory's engineer might find a use for the heat emergingfrom the other end of the pipe or develop a way to recover some of that heat towarm the fluid entering the system. Thus the redefinition of the task couldshrink energy needs even more than is implied when only the single physicalprocess, heat loss from the pipe, is considered. Very few processes in the worldeconomy have energy intensities anywhere close to the thermodynamic limits,although some basic-materials processing comes close (see American PhysicalSociety 1975).

From these considerations, it follows that the technical potential for improve-ments in energy efficiency or for energy savings means little. What matters is thepayback from each level of potential reduction, and that depends on the timingof investments, the risk involved, and access to information on which to baseinvestment decisions. Investments in energy conservation usually pay back overtime and so are influenced by expectations about the interest rate, energy prices,and the resources that will be devoted to research. Some energy-saving strategiesmake economic sense only when a system is being retired or retrofitted, whileothers may be so attractive as to merit immediate adoption. Producers of aparticular technology run the risk of not being able to sell the extra energyefficiency in the marketplace. Users need information to assess how muchenergy they will really save.

Estimating the Potential Impact of Improved Efficiency

Economists can estimate the potential for energy efficiency by using historicalanalysis to determine the elasticity of energy use with respect to price-thechange in energy use that occurs when energy prices change by a given amount.But most such elasticity estimates do not reveal whether changes in energy useare attributable to lower utilization, to modification or trade-in of equipment,or to new knowledge or tedhnology.

To get around this problem, engineering economists measure the potential forenergy conservation by estimating the amount of capital or other inputs requiredto reduce by a given amount the energy needed to operate a system. Usually theytake the reverse direction: they estimate the cost of a modification known toreduce energy use. When they string a number of technological options togetherto make a single system and rank them from highest to lowest payback, they candraw a schedule (also called a curve of supplied energy through efficiency).These estimates predict how much could be saved if certain investments weremade, and they can be calculated either for retrofit of existing systems or forchoices of new systems. In reality, few individual consumers can use such esti-mates because they do not design the products. Manufacturers are aware ofmost of these cost tradeoffs.

Where energy costs are a large component of the cost of using a particularservice, and where the service is not already being used at capacity, reducing

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energy costs could lead to increased output. Scott (1980) found this effectimportant in homes with initially poor insulation and low indoor temperaturesbut less important once indoor temperatures approached a level that could bedescribed as "saturated." Similar "usage elasticities" have been estimated formany activities, but all are believed to be small, in the range of -0.1 to -0.15.These results are consistent with the short-range price elasticity of energy usewhere energy represents virtually the only short-run cost (as for space heatingand cooling, water heating, and driving). If a system is adjusted so that, say, 30percent less energy is required to use it, with elasticity at -0.15, that systemmight be used as much as 4.5 percent more. Energy use per unit of output wouldbe reduced by about 25 percent.

The Industral Countries

Schipper and others (1992a) reviewed a wide array of literature suggesting thatthe present gap between existing and new technologies is likely to be maintainedfor the foreseeable future. In industrial economies that leaves a potential forreducing energy intensities across a wide range of technologies and ^nd-uses of20 to 25 percent by 2010. This would happen, absent a rise in energy prices,through a slow turnover of the capital stock. But Schipper and others (1992a)assume a slow rise in the real price of oil. Given that assumption, which concurswith the forecasts of most oil companies and national energy authorities (EiA1991), this reduction seems assured.

Are further reductions possible in the same time frame? Probably, if energyprices increase more rapidly. For the base scenario, assume that economicgrowth in Eastern Europe and the developing countries is rapid enough tostimulate greater-than-anticipated world demand for oil and that the world oilprice climbs. If these countries begin to remove their considerable subsidies forenergy production and internalize environmental costs, energy prices to mostend users will rise by as much as 25 percent. (Of course, the slower growth ofdemand over time could lead to slower growth in the price of oil.) For the secondscenario, assume that by 2010 the price of energy rises 25 to 50 percent over itsbase value in all countries. In the third scenario, assume that a consensus isreached about the hazards of carbon dioxide and a carbon tax is imposed in theindustrial countries of roughly $70 per metric ton ($10 per barrel of oil), whileother taxes are reduced. Together with the price changes assumed above, thisboost might increase the price of energy by as much as 50 to 100 percent,depending on the country.

Given these assumptions, Schipper and others (1992a, b) develop a set ofenergy intensities for key end-uses in 2010. These are combined with assump-tions about the activity and structure of each sector to yield total energy use.(For details of the methodology see the works cited above and Schipper andMeyers 1993). To calculate the total energy demands ir these scenarios, the

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authors assume economic growth of 2.8 percent a year between 1985 and 2010,with services growing at 3.0 percent a year and industrial output at 2.3 percent.

In the base scenario (called "trends"), intensities decline slowly. Technology in2010 is as energy-intensive, on average, as average new technology was in 1985.The price of energy during this period rises only slowly, and the average declinein energy intensities is 1.1 percent a year, reflecting the 1960-90 average. Auto-mobiles require 8.5 liters of gasoline per 100 kilometers, somewhat below the1985 level, with the change generated almost entirely in the United States. Thisscenario represents the orderly turnover of capital, which by itself leads tosignificant energy savings over time. Energy losses in producing and distributingpower fall about 10 percent from their 1985 levels as the efficiency of the powersystem increases.

In the second scenario ("efficiency push"), it is assumed, in addition to thealternative price assumptions, that the kinds of policies recommended in thepreceding section are developed. Average technology in 2010 is about as energy-intensive as the new technology with the lowest intensities in 1985. What dis-tinguishes this scenario from the base case is better marketing and increasedadoption of existing technology rather than the appearance of any radicallynew technologies. Energy intensities, weighted by 1985 end-use patterns,decline an average 2 percent a year, reflecting the situation between 1973 and1985, when the rate was 2.3 percent a year. Automobiles need only 6.5 liters ofgasoline per 100 kilometers. Losses in the production of power fall furtheras well.

In the third scenario ("vigorous effort"), even stronger policies are carried out,prompted by concerns about carbon dioxide. Manufacturers and public authori-ties undertake research, looking into ways of saving energy that might have beenconsidered radical and commercially risky in the absence of a clear consensusthat the carbon dioxide problem demands attention. New technologies aredeveloped. Energy intensities decline 3.6 percent a year, as in the 1979-83period. The efficiency of power production and distribution improves by 20percent over its 1985 average. Under these assumptions, total energy use(induding power losses) in the industrial countries rises modestly by 2010, staysthe same, or falls considerably.

For all scenarios the ratio of energy use to GDP declines by somewhat morethan the changes in intensities imply because the scenarios embody a slight shiftaway from energy-intensive activities in heavy industry and in lifestyles. Thetotal area of homes heated and the total number of electrical appliances, eachweighted by their 1985 energy use, grow less rapidly than GDP. Only traveloutpaces GDP growth (except possibly in the third scenario).

Are all three levels of energy intensity compatible with the same rate of eco-nomic growth? The answer is yes, if the higher prices in the second and thirdscenarios are imposed gradually. The reason is that the energy-cost share issmall for almost every activity in the economy and for the economy as a whole.If the potential for improvements in energy efficiency is large, and if R&D and

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strong policies expand that potential, each scenario is really only portraying asuccessive acceleration of the same energy-efficiency improvements.

The Fotner Planned Economies

Estimating the potential for energy saving in the former planned economies isboth easy and difficult. It is easy because energy use in these countries in the late1980s was so inefficient by Western standards that there is bound to be improve-ment. The inefficiency was the result of the planned nature of the economies, thelack of private ownership or private property rights that help define incentivesfor using energy efficiently, and, above all, the inordinately low energy prices,especially in the former U.S.S.R., probably the nation with the heaviestsubsidies.

The difficult part of this estimate is trying to gauge the time frame duringwhich efficiency improvements will occur. It will take a long time for both thepublic and private sectors, including households, to learn how energy marketswork, how to respond to signals by changing technology or behavior, and howto find out what changes save the most energy. Much of the saving should bedebited not to energy conservation but to the reform process itself.

The implied improved quality would reduce electricity consumption by 25percent over present levels. Thus it is uncertain how much efficiency arisespurely from the processes of reform and revitalization and how much occursbecause consumers make calculated investments in energy-efficient technologyor turn to energy-conscious practices in homes or factories.

These estimation problems were circumvented by comparing the uses ofenergy in the former U.S.S.R. and, more recently, Poland with similar uses inthe West. Scenarios similar to those described above for the industrial countrieswere developed for the former U.S.S.R. The three scenarios represent the pre-sent situation ("slow reform)"; a scenario that assumes relatively modest successin introducing a market economy and in which energy prices rise significantly inreal terms ("rapid reform"); and a scenario in which energy prices rise to indus-trial country levels and Western firms actively compete within the formerU.S.S.R. ("extra effore"). In all three cases the economy declines until 1995 andthen grows at 3 percent a year through 2010, reaching 150 percent of its 198Slevel of energy use. (For details, see Schipper and Martinot 1993a.)

The efficiency potentials in the scenarios, which may be taken as representa-tive of most of the formerly planned economies, illustrate the response to theintroduction of a market economy and increases in energy prices. In "slowreform,' intensities in 2010 are 10 to 20 percent below their 198S levels and areroughly on a par with those of the industrial countries in 1970. In "rapidreform," the average intensities in 2010 reach those seen in Western Europebetween 1985 and 1990. Although this gap is substantial, it represents a smallerdifference than in 1985, when much Soviet technology was at about the 1947-55 Western level. It is almost inevitable that the gap will narrow as more

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Western technologies are adopted and, just as important, as practices frommarket economics come to dominate energy use. In "extra effort," an all-outpush to modernize the former U.S.S.R., coupled with aggressive efficiency poli-cies, brings about intensities that are close to those in the industrial countries'"trends" scenario for 2010, representing a considerable contraction of the effi-ciency gap between East and West.

Even in the "slow reform" scenario, cnergy use in the former U.S.S.R. in 2010is dose to its 1985 level, despite the increase in economic activity. In "rapidreform," under relatively modest assumptions about efficiency improvementsand structural change, energy use falls. The enormous drop in energy intensitiesestimated for "extra effort"-50 percent, on average, compared with 1985-may be unrealistic, but it provides a good illustration of what could happen.

The Developing Countres

Although estimating energy savings in developing countries is problematic,Schipper and others (1992a) conclude that the potential for further improve-ment is generally greater than in the industrial countries. Much of the technol-ogy is old or second-hand, and closed borders and distortions in factor pricesboost energy intensities. Yet some developing economies, notably Brazil, Korea,Singapore, and Taiwan (China), are already producing and employing state-of-the-art energy-saving technologies in some sectors. Clearly, efficiency couldcontinue to improve.

In which sectors of developing countries will policies for encouraging energyefficiency be most effective? To answer this question, we need to know howmuch improvement in energy efficiency will occur anyway as countries develop,markets mature, expertise grows, energy and other factor prices are adjusted,and people get used to managing commercial fuels and electricity.

We know that the ratio of energy to output in manufacturing fell continuallyin major industrial countries over decades, and-where we have observations-in many middle-income developing countries, as well. Undoubtedly, a great dealof improvement will occur in industry and in large commercial buildings becauseof pressures from electric utilities concerned about peak period power consump-don. Financing arrangements for housing influence whether homes are insulatedor have windowshades and other features that reduce the need for heating andcooling. Tariffs and taxation determine the size and power of cars. Regulationsconcerning the building and financing of roads and rails wili affect the mix andutilization of freight modes, as well as the energy intensities of each mode. And,to some extent, building regulations and traditions, particularly those affectingschools, hospitals, hotels, and offices buildings, may determine whether newstructures incorporate energy- and electricity-saving features, to the benefit offuture occupants. Al these policies will affect transport and household energyuse.

422 Energy Efficiency

Our poor understanding of the wide range of energy intensities in developingcountries complicates the estimation of potential energy savings. The infonna-tion we have for countries in Asia and Latin America suggests the same largepotential as in the industrial and the formerly planned economies.

To illustrate, Schipper and Meyers (1991) developed three scenarios for resi-dential use of electricity in urban Java that are similar to those for the industrialcountries and the former U.S.S.R. In contrast to those countries, however,energy use grows considerably in all three scenarios.

Sathaye and Ketoff (1991) expanded this work to include oil producers, high-and low-income countries, relatively urbanized and very rural countries, and thetwo most populous countries in the world, China and India. They calculatedthat the potential for reducing energy use in these countries in 2025 over a basecase was approximately 25 percent. But their base case assumed already signifi-cant improvements in efficiency over 1985. With energy intensities frozen at1985 levels, the share of energy costs in GDP would rise.

Sathaye and Ketoff's "trends" case (with frozen intensities) shows higherenergy use than their base case, which-because of its improvements inefficiency-resembles "efficiency push" in the industrial countries. Their "vig-orous effort" case shows a reduction in intensities of nearly 50 percent over aperiod of forty years. This rate of decline of 1.1 percent a year resembles theobservations in the industrial countries between 1950 and 1985. All three casesassume an expansion of energy, particularly for travel and dimate control.These are the two sources of expansion that offset the enonnous declines in theratio of industrial energy use to output in Japan and the FRG in the 1960s andearly 1970s. Thus these scenarios are consistent with the experience of majorcountries in the industrial world during a period of falling real energy prices.The results are probably conservative because energy prices in most developingcountries are likely to rise to cover the cost of new equipment and possibly evenof cleaning up pollution (but not necessarily of reducing carbon dioxide.)

Summary

The scenarios for all countries illustrate the potencial for gready improved effi-ciency in energy use. If it is accompanied by the opening of markets, the intro-duction of efficiency programs, and R&D and marketing of new efficient technol-ogies, greater -flciency could act to restrain or even contract growth in energyuse.

Several common themes emerge in these scenarios. First, some improvementin energy use will occur even if world oil prices rise slowly rather than rapidly.This will be the result of (a) the large gap between existing and new technologiesin the industrial countries, (b) reform and price changes in the formerly plannedeconomies, and (c) reform, price changes, and economic growth in the develop-ing countries. A variety of policies could encourage energy users to speed up

Schippef 423

their adoption of more efficient technologies and producers to develop evenmore efficient equipment.

Second, energy technologies are becoming universal. Transport and buildingequipment and household appliances are increasingly made for world markets.The Java study confirmed that older and less rfficient technologies tend to besold in the developing countries (Schipper and Meyers 1991). But the gapbetween what is sold there and what is sold in the wealthy countries is gettingsmaller because more of the best technologies are being manufactured in thedeveloping countries. The same is true for the former planned economies, whererapidly opening markets are permitting citizens to buy better imported technolo-gies, while local companies, anxious to sell in the industrial countries, are forcedto improve the quality and energy efficiency of their products.

Finally, pricing is extremely important to the efficient use of energy. There isroom for improvement in energy-use markets in every country and region. Cer-tain successful policies employed in the past, suitably updated, could be usefullypursued in the future. It is meaningless to determine potentials without niakingassumptions about the energy prices at which these potentials make economicsense. But it is equally pointless to ignorc market frictions and other problemsthat will hinder the achievement of these levels of efficiency.

Conclusion

The anticipated economic expansion of developing countries and the eventualrecovery of the former planned economies point to an enormous growth inworld demand for energy. The scenarios in the preceding section outlined therange of future demands at various energy prices and under various policyoptions. The central theme of this paper is that much of the growth in demandcould be offset by improved use of energy.

The factors that cause declines in energy use and pollution and increases inefficiency suggest some "ingredients" that should go into policies for restrainingenergy use and reducing environmental problems.

* Abolishing subsidies for energy production aid consumption* Internalizing enviromnental costs through taxes or fees* Implementing sectoral policies to encourage greater energy efficiency• Expanding R&D on energy use* Supporting public-private, North-South, and East-West cooperation to fos-

ter the dissemination of energy-efficient technologies* Restraining population growth rates to ease pressures on total energy use

(see Schipper and others 1992a).

The following are the most important sectoral policies for encouraging greaterenergy efficiency:

* Setting efficiency standards for household equipment and some buildingequipment

424 -- En"y Efficiency

* Providing incentives for more rapid development and marketing of technol-ogies that go beyond these standards

* Financing efficiency improvements in housing and other new and existingpublic buildings

* Introducing transport policies that both improve and restrain traffic andreduce exhaust emissions

* Introducing industrial policies that promote competition and the develop-ment of new industrial technologies.

These measures could virtually eliminate the growth of energy demand in theindustrial countries and forner planned economies and halve its rate of growthin the developing countries through 2010, reducing pollution and carbon diox-ide emissions as well.

Why should we favor energy-efficiechcy policies, beyond the need to get energyprices right? Because there are social benefits from early reduction of pollution.The sooner we introduce efficiency measures, the sooner we will have a cleanerenvironment. More important, these policies could offer new opportunities forsaving energy that otherwise might not become available until much later, ifever.

In the final analysis, the public's perceptions about the nature and depth ofenvironmental problems are all-important. If the political consensus for environ-mental restraint indudes promoting energy efficiency, ordinary rules for encour-aging economic efficiency should be followed, rather than special criteria thatfocus on energy. Some interventions for energy efficiency have focused on eco-nomnic efficiency in the past, and others like them could be attempted in thefuture. Carefully developed efficiency policies are vital to creating a market forgreater efficiency.

Notes1. John P. Holdren is professor of energy and resources at the University of California and a recipient

of both the MacArthur Prize and the Volvo Environment Prize.2. Holdren's scenario assumed that per capita economic activity in developing countries would expand

by 3 to 4 percent per year, while per capita energy use would grow by only 2 percent.3. To detenmnine "structure-corrected" intensities or "coristant structure," the mix of production or

modes within a sector is held constant and the ef