How do you get businesses and people to make the right choices? It's an age old question. Is it better to hold the proverbial "gun to the head" via taxes and regulation, or might other, subtler ways achieve the same result? In the debate over what to do about climate change, many argue that the only solution is regulations and taxes. Unfortunately, there's a lot of opposition to regulations and taxes, even from those who very much believe climate change is a very real problem. Instead of that "gun to the head", why not try to nudge people to make the right decision? It's a lot more gentle approach, but it could be way more effective.
Recently the Tennessee Valley Authority (TVA), a Federal government entity that operates electric utilities serving ten million people in seven southeastern states of the USA, decided to close two aging coal-fired power plants, one near Paradise, Kentucky and the other near Knoxville, Tennessee.
The politicians howled, all the way to President Donald Trump, because of the loss of coal jobs.
Not to be deterred, Bill Johnson, CEO of the TVA said, "Let me tell you what this decision is not about – it's not about coal. This decision is about economics." Economics indeed! The TVA estimates it will save about $ 1.3 billion by closing the plants due to not needing to make costly plant upgrades. When you bandy about numbers like that, even climate skeptics will pay attention.
The economics of closing these plants may well be a "flash of the blindingly obvious." In lots of other cases, however, it may not be quite so clear. Yet it seems pretty clear that if we're going to get a significant reduction in greenhouse gas emissions, more such plants need to be closed.
So if you want to get these plants closed, what alternative is there to regulation and taxes? It could be a gentle "nudge". Nudge theory was originally developed by Professor Richard Thaler. While he has worked on the concept for many years, it became well known in 2009 when Thaler, along with law professor Cass Sunstein, published a book on it.
The "nudge" concept is to use positive reinforcement and indirect suggestions as ways to influence the behavior and decision making of groups or individuals.
How important is the concept? Well, Thaler received the Nobel Prize in Economics in 2017 for this work.
Let me show you some examples of nudge theory, then show how it might be applied in the case of greenhouse gas emissions.
Consider the problem of getting people to donate organs. Lots of people say, sure, I'd be willing to donate an organ. Most states provide a simple way to make this offer through a driver's license. The problem is, lots of people are honestly happy to do this, but fail to follow through.
The country of Spain, applying Thaler's nudge theory, came up with a solution. Spain started automatically enrolling people in an organ donation scheme. Realizing that some people would object, they also provided a way to "opt out". The result is that Spain now has the highest percentage of organ donors in the world – all thanks to a little nudge.
A few years ago the United Kingdom found that many people were not doing a good job saving for retirement. The government had a pretty good pension scheme available, and surveys showed a high percentage of people knew it was important to save. Unfortunately, like would be organ donors, they just didn't get around to signing up.
The solution was a little nudge in the form of automatic enrollment in the pension scheme with an "opt out" clause for those who didn't want it. The result was an increase in participation from 2.7 million in 2012 to 7.7 million in 2016, and it came without the usual hollering and screaming there would have been if government had mandated the solution.
A further example of a nudge is how children are enrolled in free school meals programs. The system was changed from opt in to opt out, resulting in a significant increase in participation.
Simply put, a nudge can be an effective way to achieve a desired result without "holding a gun to someone's head".
Of course, it's one thing to try to nudge individuals to consider organ donations or enrollment in a pension scheme, but quite something different to try to nudge a company to stop emitting greenhouse gases into the atmosphere.
Or is it? A simple examination of utility economics may tell a different story.
The two aged TVA coal fired plants mentioned earlier are definitely not atypical. According to the US Energy Information Agency, 51% of power generating capacity in the USA was built before 1980, and 88% was built between 1950 and 1990. The capacity weighted age of those coal plants is 39 years. Put another way, most of those coal plants are ready for retirement .
TVA isn't the only utility trying to decide what to do about old coal fired plants. The great fear is that these utilities will either upgrade existing plants to keep them running, or replace them with new coal plants or possibly plants powered by other fossil fuels such as natural gas. Natural gas plants are better than coal plants because they emit only about half as much greenhouse gas, but that could still be a lot of greenhouse gas.
The good news is that most utilities aren't thinking about replacing these aging plants with new coal plants, but they could very well replace them with natural gas plants. However, some conveniently placed "nudges" might get them to act differently.
How might utilities be nudged to act differently? The key way is through the utility ratemaking process. Most electric utility rates are set by state government agencies. The utility presents data to the commission on how much it costs to operate the plant, as well as the capital cost of the facility. The rate is calculated in such a way to provide the utility a defined rate of return on the assets. The utility could be "nudged" through slight changes in the allowed rate of return on the assets, or in how the expenses are treated.
One obvious nudge would be to permit a higher rate of return to the utility if it will replace the coal plant with a solar or wind powered unit. The allowable rate of return might only be adjusted slightly, possible one half of one percent. That may not sound like a lot, but it could make a big difference to the utility's management and shareholders.
Another possible change might be to adjust the depreciation schedules on certain classes of assets for a new plant. For example, the utility commission might allow faster depreciation of a new plant, thus increasing the effective utility rates in the short term.
These are examples of simple economic nudges that could get the utility to do one of the following: 1) retire an old coal plant rather than do upgrades/retrofits; or 2) retire an old coal plant and replace it with a wind or solar plant rather than a natural gas one. When all is said and done, it's about economics. The challenge is to provide appropriate nudges to each utility in order to get them to make decisions that are more beneficial for the environment.
Of course, at the end of the day, the kinds of economic nudges described above would have the same impact as a carbon tax, the preferred tool of the typical economist. The idea of a carbon tax is to take into account the effective cost of greenhouse gases. The nudges proposed above could have the same impact as a carbon tax, just without enacting a carbon tax. The nudges might increase the cost of power in the short term, much as a carbon would. However, once a new plant is in place, the cost of operation would likely decrease. In fact, over a period of time, the customers of the utility might end up paying a lower total cost than before because the older, more expensive plant will be replaced by a lower cost, more environmentally friendly one.
Another feature of this nudge strategy is that it can be tailored to location conditions whereas something like regulations or taxes tend to be more "one size fits all". Even within a given state, the appropriate nudges for different facilities may be different. Thus if the goal is to get a given plant retired more quickly, and ideally replaced with an alternative energy plant, the following generic strategy makes sense: 1) determine the magnitude the required economic nudge; 2) identify possible ways the economic nudge might be implemented; 3) select the nudge that seems most likely to fit the local political conditions; and 4) identify potential allies to help get the nudge implemented. Surprisingly, utility management might be an ally, but not really that much of a surprise when you consider that the leaders of electric utilities can see which way the wind is blowing.
A key reason utility management might be an unexpected ally is because the economics of alternative energy have changed so drastically in the past few years. A new alternative plant will likely be less expensive to operate than a coal plant, or even a natural gas one. Utility managers aren't blind to that. They just may need a nudge to make the change now instead of later.
Of course, this isn't a panacea, but it could be a much more effective strategy than trying to "hold a gun to everyone's head", the problem with most taxes and regulations. As previously noted, most of these coal fired electric utilities are getting very old. They're expensive to maintain. There's a very good chance the electric utility owners will be very happy to get rid of them. Just like putative organ donors and people needing to sign up for a pension scheme, all they need is a little nudge.
