Overcoming the free rider problem

The green arrows represent the circulation of money.

Recently, a columnist syndicated in this paper wrote a polemic against Ontario’s rebate for purchasing an electric car. She cites a friend whose new $140,000 Telsa garnered almost $10,000 in taxpayer-funded rebates intended to encourage the purchase of electric cars, but claims he would have bought that car anyway. Based on this, she complains the subsidy should only apply to lower-priced (non-luxury) vehicles, and that we are being unfair to less-affluent people (among whom she includes herself, despite being a syndicated national columnist) who buy a fuel-efficient gasoline car or ride transit.

While I object to several of her lines of reasoning, not least her attempt to pit rich against poor (and class herself with the poor) to attack a program that, in practise, mostly applies to more modestly-priced cars purchased by the middle class (this rebate was the deciding factor in my own recent purchase of an electric vehicle), she is getting close to describing a real problem in our governments’ approaches to addressing climate change.

Her appeal to nationalism – Teslas are made in California, while some economy cars are manufactured in Ontario (albeit by foreign parent companies) – is another red herring. The support of the right-wing for increased free-trade deals that outlaw buy-local programs is consistent, and the purpose of a new-technology purchase rebate isn’t to reward domestic manufacturers, but to create a new market that might attract that manufacture.

Nevertheless, what she is getting at, without naming it, is the “free rider” problem of energy efficiency subsidies, which has been studied by economists. Basically, assuming we want society to adopt cleaner or more efficient technologies that are stalled by the high cost for early adopters (a chicken-and-egg problem), then it makes sense to have some kind of financial incentive to encourage people. But since energy efficiency saves money in the long run, some people will be doing it already, yet they will also apply for the incentives. Any who would have done the green thing anyway, without needing a government hand-out, are the so-called “free riders”. If there are, for example, 3 free riders for each person whose decision was affected by the incentive, then you are spending $4 of subsidy for $1 of effective change. And I agree, that is not efficient use of taxpayer money.

So what to do instead? If pundits like this columnist would actually consult with economists, they would learn that the most effective approach is a carrot-and-stick, starting with the stick. The “stick” is a higher price on energy, particularly fossil energy, which increases the savings incentive to those who upgrade or conserve. You can then use that revenue to help fund alternatives, such as transit, or you can refund it to everyone equally, to help them all pay for improvements themselves. Either way, you achieve energy savings much more effectively for the dollars raised and spent, a more fiscally responsible course.

Another approach is to offer government loan guarantees allowing people to switch to new or more efficient energy without an up-front cost, by recovering the loan out of the monthly energy savings, something government can do at a very low cost.

However, since this same columnist seems to be very much against things like using new revenue to fund better transit (despite using transit users as her proxy suffering taxpayer) or using government debt to fund anything, then I doubt she will be interested in this non-partisan economic advice. Too bad, because it is a strong solution to the problem she has identified.

An edited version of this was published as my Root Issues column in the Barrie Examiner as "No more free rides for energy efficiency program"

Erich Jacoby-Hawkins is a director of Living Green and the Robert Schalkenbach Foundation.