- Email: [email protected]
Peter Chapman adds
C o m m u n i c a t i o n s on e n e r g y
be shown to be sub-optimal according to economic criteria. Legislation which requires the energy analysis of projects is not the same thing as legislation which ensures that decisions will be taken solely on the basis of EA. The final issue raised in Webb and Pearce's reply is that of the evaluative role of energy analysis. In their reply, they state that energy analysis claims for itself an evaluative role, and they provide some quotations taken to support this statement. However, in their original assessment they state that 'we are very much aware that energy analysts, in the main, have declared, in some cases repeatedly, that EA is not evaluative'. 2 On this point I suspect that the origin of confusion lies, both for Webb and Pearce and for some energy analysts, in an insufficiently explicit consideration of the inputs to evaluation. In their reply Webb and Pearce find me agreeing with them that 'energy analysis serves no evaluative function', and, since this is definitely not my view, it is clear that 1 was insufficiently explicit. My point was that while it is the case that energy analysis, a descriptive exercise, cannot itself be a technique for project evaluation, or equivalently for the derivation of optimal allocation rules, it can be an input to evaluation. I take it that the descriptive exercise is concerned with constraint specification, and note that the appropriate specification of constraints is an integral part of any exercise in evaluation. I now provide a purely illustrative example of the derivation of optimal allocation rules. Consider an economy with consumption goods YI and Y2, produced using inputs E and L. The planners for this economy derive their optimal allocation rules by maximising a welfare function defined on YI and Y2, subject to the constraints that the total available amounts of E and L are fixed. That is, they consider the following problem:
Maximise kV(Y1,Y2 ) subject to: Yl
= FI ( E t , L I )
Et + E z = ff
160
The Lagrangian for this problem is:
t : ~,(r,,r:)+x, +)t 2
IF, ( E 2 , L , ) -
[r, (e,,t,)
r,]
Vii ÷ O, [ L L ,
L2]
+0,
The necessary conditions maximum here are:
for
a
w~-Xz =0, w2-X2=0 X l f l E - 02 = O, )`2[;fi"
05 = 0
)`~f~L-Ol=O, )`2f2L-O~ =0 plus the original constraints, where wI = a W / ~ Y z , e t c . From these necessary conditions we can derive the following rules characterising an optimal allocation of resources: w.-2= )'2 w2 X2 f-i-e = -f -i e = -05
fit
-fit
welfare. The positive statement 'the constraints are B rather than A', together with W(YII ,Y2 ), leads to the normative statement 'follow allocation rules D rather than C'. The point is simply that maximising an invariant objective function under different sets of constraints yields different optimal allocation rules. This is not at all an original point, but it appears necessary that it be made again.
Michael S. Common, The University of Southampton, Southampton, England 1 M. Common, 'The economics of energy analysis reconsidered', Energy Poficy, Vol 4, No 2, June, 1976, p 159. 2 M. Webb and D. Pearce, The economics of energy analysis', Energy Policy, Vol 3, No 4, December, 1975.
0,
S2__e= f2_b - x2 = w~ fZE
f~L
~1
Peter Chapman adds
wl
Now, consider that the planners are informed that their understanding of the constraints they face is incomplete. Suppose that it is actually the case that the input E is not only limited in total availability, but that it also has to be used in fixed proportions in the two productive activities. The problem is to maximise W(YI ,Y2 ) subject to: Yt =Fa (Et,Lt) Y2
=
F2 (E2,L2)
LI +L2 =L
E, +E2 =E El = kE2
This leads to the following rules characterising an optimal allocation of resources: Wl - - = -)`1 -
w2 )`~
f~[:_82-63 f21~=02*k03 /LL
O~
f~L
O~
[02-0/i
2 x, L02 + kO~J I2t
x,
These are not the same optimal allocation rules as those above, though the value judgments embedded in the welfare function W(YI,Y2) have not changed. What has changed is the planners' appreciation of the constraints subject to which they seek to maximise
In a recent paper Webb and Pearce l have attempted to portray energy analysis as a 'technique in search of a function'. They presume that all techniques must either be evaluative, and hence of use to policy-makers, or non-evaluative, in which case they are of no use. They raised several other issues, based on misunderstanding, which have been partly corrected by others. 2 The aim of this short note is to demonstrate that the classification of techniques used by Webb and Pearce is an empty classification, and to offer an explanation of why this strange view of energy analysis should have arisen in their work. In the realm of policy evaluation it is accepted that there is no technique for constructing policy objectives. The objectives of a government, a corporation, or any other institution are formulated by a political process. This will include both the statement of objectives and their ranking in order of priority. Neither economics nor energy analysis nor any other technique of analysis is able to deduce what 'ought' to be an objective. The roles of techniques of analysis can be to convert a stated objective into an objective function, to establish relationships between the variables included in the formulation of the objective function, or the formulation of the constraints, under
E N E R G Y POLICY June 1977
Communications on energy
which the objective function has to be maximised (or minimised). A useful example of an institutional objective is the allocation of a sum of money in the Department of Energy to promote energy conservation. Energy conservation is not in itself a 'good' thing, but it is one of the objectives of the present government faced with a very large oil-import bill. Its significance in the pecking order of policy objectives can be gauged from the level of funds devoted to its implementation. It is certainly lower in priority in the UK than in many other countries where substantially larger fractions of government expenditure have been devoted to energy conservation. But it is not the role of energy analysis, nor economics, to challenge this ranking that can be, and often is, challenged in the political processes. The role of energy analysis and economics, given the above objective, is to try to clarify the relationships between energy consumption and other variables in the economy so that those trying to implement the policy are aware of the likely outcome of their actions. Should the government try to promote the insulation of buildings? Is the energy used in making insulation materials greater or less than the energy saved as a result of insulation? It is difficult to see how, without an answer to this latter question, a civil servant could decide whether promoting building insulation would or would not conserve energy. Similar remarks apply to the imposition of speed limits, the promotion of materials recycling and so on. If an energy analyst demonstrates that insulating buildings does reduce energy consumption this does not imply that insulating buildings ought to be a policy objective. What it does say is that /f you have a policy objective to reduce energy consumption then here is one action that might be taken. A thorough analyst would, it is hoped, continue in his search to find as many other actions as are available for the achievement of the policy objective. Once a list of all possible 'energy conserving' actions are assembled then those responsible for achieving the conservation objective will have to apply other analytical methods to understand the non-energy implications of possible actions. These would
ENERGY
POLICY
June
1977
probably include labour analysis, environmental impact analysis, analysis of any effect on balance of trade and so on. In documenting the employment effects of a possible line of action the labour analyst is no more advocating a labour theory of value than an energy analyst is advocating an energy theory of value. In addition to weighing the significance of the energy, employment, environmental, etc effects of any action, the policy maker will also have to weigh the relative timing of the impacts. In particular he may have to assess the significance of immediate energy savings (when the oil deficit is significant) against those in the medium term (when domestic production is likely to exceed supply) and those in the long term (when genuine energy scarcity is a possibility). In doing so be will be attempting to put shadow prices on the energy at different times and applying some appropriate discount rate. But the point that Webb and Pearce seem unable to grasp is that this economic refinement can only be done when the policy-maker has a clear statement of what the energy flows (or savings) will be at different times. In this sense the energy analyst is providing data for policy evaluation in exactly the same sense as the petroleum geologist provides data on oil flow rates to assist oil companies assess their investment opportunities. In providing data on oil flow rates the petroleum geologist is not pre-empting or reformulating any of the company's objectives; he is providing data essential for a thorough analysis. Again it is difficult to see how an oil company could use economic analysis only to decide whether a particular field is worth exploiting. Energy analysis, in so far as it can integrate environmental and technical knowledge into process data, can also provide constraints under which policies must operate. If a new constraint is introduced into an optimisation problem then the nature of the solution to the problem may change. This does not mean that the constraint has an evaluation function, but it may very well alter the evaluation (in an economic/optimisation sense) of the range of possible actions. Thus in addition to providing data essential for the analysis of energy policy options,
energy analysis may also have an important role in formulating constraints on policy. All the above arguments are concerned, ultimately, with the role of information in economics. It is unfortunate, to say the least, that the best developed and most applied economic model, that of the competitive market, presumes that all economic agents have adequate, even perfect, information? This presumption of adequate information makes any information-gathering activity appear redundant in an economic paradigm. Indeed it is sometimes presumed by economists that their model of the world is sufficiently accurate to enable them to deduce hitherto unknown information from prices, when in fact their own theory demands that for this information to be incorporated in prices it must already be known by all economic agents. 4 This is the logical fault in Webb and Pearce's critique of energy analysis in that they presume that prices contain all necessary energy information, when it is in fact unknown. Thus by presuming perfect information they can see no function for an information gathering technique. Surprise, surprise!
Peter F, Chapman, The Open University, Milton Keynes, UK.
1M.G. Webb and D.W. Pearce, 'The economics of energy analysis', Energy Poficy, Vo13, No4, December, 1975, p318. 2 M. Common, 'The economics of energy analysis reconsidered', Energy Policy, Vol 4, N o 2 , J u n e 1976, pp 158-165. 3 Several economists have attempted to analyse the operation of competitive markets under varying assumptions about information. While such efforts are laudable, the significance of their work has gone largely unnoticed in the general run of economics. 4This is also the reason why Webb and Pearce fail to understand the example of copper ore grade referred to in their paper. If one presumes that prices contain information about the long-term availability of a material, then it would appear foolish to perform a wide range of analyses to discover that availability - and this is what Webb and Pearce accuse energy analysis of doing.
161
be shown to be sub-optimal according to economic criteria. Legislation which requires the energy analysis of projects is not the same thing as legislation which ensures that decisions will be taken solely on the basis of EA. The final issue raised in Webb and Pearce's reply is that of the evaluative role of energy analysis. In their reply, they state that energy analysis claims for itself an evaluative role, and they provide some quotations taken to support this statement. However, in their original assessment they state that 'we are very much aware that energy analysts, in the main, have declared, in some cases repeatedly, that EA is not evaluative'. 2 On this point I suspect that the origin of confusion lies, both for Webb and Pearce and for some energy analysts, in an insufficiently explicit consideration of the inputs to evaluation. In their reply Webb and Pearce find me agreeing with them that 'energy analysis serves no evaluative function', and, since this is definitely not my view, it is clear that 1 was insufficiently explicit. My point was that while it is the case that energy analysis, a descriptive exercise, cannot itself be a technique for project evaluation, or equivalently for the derivation of optimal allocation rules, it can be an input to evaluation. I take it that the descriptive exercise is concerned with constraint specification, and note that the appropriate specification of constraints is an integral part of any exercise in evaluation. I now provide a purely illustrative example of the derivation of optimal allocation rules. Consider an economy with consumption goods YI and Y2, produced using inputs E and L. The planners for this economy derive their optimal allocation rules by maximising a welfare function defined on YI and Y2, subject to the constraints that the total available amounts of E and L are fixed. That is, they consider the following problem:
Maximise kV(Y1,Y2 ) subject to: Yl
= FI ( E t , L I )
Et + E z = ff
160
The Lagrangian for this problem is:
t : ~,(r,,r:)+x, +)t 2
IF, ( E 2 , L , ) -
[r, (e,,t,)
r,]
Vii ÷ O, [ L L ,
L2]
+0,
The necessary conditions maximum here are:
for
a
w~-Xz =0, w2-X2=0 X l f l E - 02 = O, )`2[;fi"
05 = 0
)`~f~L-Ol=O, )`2f2L-O~ =0 plus the original constraints, where wI = a W / ~ Y z , e t c . From these necessary conditions we can derive the following rules characterising an optimal allocation of resources: w.-2= )'2 w2 X2 f-i-e = -f -i e = -05
fit
-fit
welfare. The positive statement 'the constraints are B rather than A', together with W(YII ,Y2 ), leads to the normative statement 'follow allocation rules D rather than C'. The point is simply that maximising an invariant objective function under different sets of constraints yields different optimal allocation rules. This is not at all an original point, but it appears necessary that it be made again.
Michael S. Common, The University of Southampton, Southampton, England 1 M. Common, 'The economics of energy analysis reconsidered', Energy Poficy, Vol 4, No 2, June, 1976, p 159. 2 M. Webb and D. Pearce, The economics of energy analysis', Energy Policy, Vol 3, No 4, December, 1975.
0,
S2__e= f2_b - x2 = w~ fZE
f~L
~1
Peter Chapman adds
wl
Now, consider that the planners are informed that their understanding of the constraints they face is incomplete. Suppose that it is actually the case that the input E is not only limited in total availability, but that it also has to be used in fixed proportions in the two productive activities. The problem is to maximise W(YI ,Y2 ) subject to: Yt =Fa (Et,Lt) Y2
=
F2 (E2,L2)
LI +L2 =L
E, +E2 =E El = kE2
This leads to the following rules characterising an optimal allocation of resources: Wl - - = -)`1 -
w2 )`~
f~[:_82-63 f21~=02*k03 /LL
O~
f~L
O~
[02-0/i
2 x, L02 + kO~J I2t
x,
These are not the same optimal allocation rules as those above, though the value judgments embedded in the welfare function W(YI,Y2) have not changed. What has changed is the planners' appreciation of the constraints subject to which they seek to maximise
In a recent paper Webb and Pearce l have attempted to portray energy analysis as a 'technique in search of a function'. They presume that all techniques must either be evaluative, and hence of use to policy-makers, or non-evaluative, in which case they are of no use. They raised several other issues, based on misunderstanding, which have been partly corrected by others. 2 The aim of this short note is to demonstrate that the classification of techniques used by Webb and Pearce is an empty classification, and to offer an explanation of why this strange view of energy analysis should have arisen in their work. In the realm of policy evaluation it is accepted that there is no technique for constructing policy objectives. The objectives of a government, a corporation, or any other institution are formulated by a political process. This will include both the statement of objectives and their ranking in order of priority. Neither economics nor energy analysis nor any other technique of analysis is able to deduce what 'ought' to be an objective. The roles of techniques of analysis can be to convert a stated objective into an objective function, to establish relationships between the variables included in the formulation of the objective function, or the formulation of the constraints, under
E N E R G Y POLICY June 1977
Communications on energy
which the objective function has to be maximised (or minimised). A useful example of an institutional objective is the allocation of a sum of money in the Department of Energy to promote energy conservation. Energy conservation is not in itself a 'good' thing, but it is one of the objectives of the present government faced with a very large oil-import bill. Its significance in the pecking order of policy objectives can be gauged from the level of funds devoted to its implementation. It is certainly lower in priority in the UK than in many other countries where substantially larger fractions of government expenditure have been devoted to energy conservation. But it is not the role of energy analysis, nor economics, to challenge this ranking that can be, and often is, challenged in the political processes. The role of energy analysis and economics, given the above objective, is to try to clarify the relationships between energy consumption and other variables in the economy so that those trying to implement the policy are aware of the likely outcome of their actions. Should the government try to promote the insulation of buildings? Is the energy used in making insulation materials greater or less than the energy saved as a result of insulation? It is difficult to see how, without an answer to this latter question, a civil servant could decide whether promoting building insulation would or would not conserve energy. Similar remarks apply to the imposition of speed limits, the promotion of materials recycling and so on. If an energy analyst demonstrates that insulating buildings does reduce energy consumption this does not imply that insulating buildings ought to be a policy objective. What it does say is that /f you have a policy objective to reduce energy consumption then here is one action that might be taken. A thorough analyst would, it is hoped, continue in his search to find as many other actions as are available for the achievement of the policy objective. Once a list of all possible 'energy conserving' actions are assembled then those responsible for achieving the conservation objective will have to apply other analytical methods to understand the non-energy implications of possible actions. These would
ENERGY
POLICY
June
1977
probably include labour analysis, environmental impact analysis, analysis of any effect on balance of trade and so on. In documenting the employment effects of a possible line of action the labour analyst is no more advocating a labour theory of value than an energy analyst is advocating an energy theory of value. In addition to weighing the significance of the energy, employment, environmental, etc effects of any action, the policy maker will also have to weigh the relative timing of the impacts. In particular he may have to assess the significance of immediate energy savings (when the oil deficit is significant) against those in the medium term (when domestic production is likely to exceed supply) and those in the long term (when genuine energy scarcity is a possibility). In doing so be will be attempting to put shadow prices on the energy at different times and applying some appropriate discount rate. But the point that Webb and Pearce seem unable to grasp is that this economic refinement can only be done when the policy-maker has a clear statement of what the energy flows (or savings) will be at different times. In this sense the energy analyst is providing data for policy evaluation in exactly the same sense as the petroleum geologist provides data on oil flow rates to assist oil companies assess their investment opportunities. In providing data on oil flow rates the petroleum geologist is not pre-empting or reformulating any of the company's objectives; he is providing data essential for a thorough analysis. Again it is difficult to see how an oil company could use economic analysis only to decide whether a particular field is worth exploiting. Energy analysis, in so far as it can integrate environmental and technical knowledge into process data, can also provide constraints under which policies must operate. If a new constraint is introduced into an optimisation problem then the nature of the solution to the problem may change. This does not mean that the constraint has an evaluation function, but it may very well alter the evaluation (in an economic/optimisation sense) of the range of possible actions. Thus in addition to providing data essential for the analysis of energy policy options,
energy analysis may also have an important role in formulating constraints on policy. All the above arguments are concerned, ultimately, with the role of information in economics. It is unfortunate, to say the least, that the best developed and most applied economic model, that of the competitive market, presumes that all economic agents have adequate, even perfect, information? This presumption of adequate information makes any information-gathering activity appear redundant in an economic paradigm. Indeed it is sometimes presumed by economists that their model of the world is sufficiently accurate to enable them to deduce hitherto unknown information from prices, when in fact their own theory demands that for this information to be incorporated in prices it must already be known by all economic agents. 4 This is the logical fault in Webb and Pearce's critique of energy analysis in that they presume that prices contain all necessary energy information, when it is in fact unknown. Thus by presuming perfect information they can see no function for an information gathering technique. Surprise, surprise!
Peter F, Chapman, The Open University, Milton Keynes, UK.
1M.G. Webb and D.W. Pearce, 'The economics of energy analysis', Energy Poficy, Vo13, No4, December, 1975, p318. 2 M. Common, 'The economics of energy analysis reconsidered', Energy Policy, Vol 4, N o 2 , J u n e 1976, pp 158-165. 3 Several economists have attempted to analyse the operation of competitive markets under varying assumptions about information. While such efforts are laudable, the significance of their work has gone largely unnoticed in the general run of economics. 4This is also the reason why Webb and Pearce fail to understand the example of copper ore grade referred to in their paper. If one presumes that prices contain information about the long-term availability of a material, then it would appear foolish to perform a wide range of analyses to discover that availability - and this is what Webb and Pearce accuse energy analysis of doing.
161