The Prius Conundrum

Dan Ariely asks why people are more willing to shell out for a Prius than they are to spend a similar amount of money to save much more CO2 by making their houses energy-efficient. And I think a large part of the answer is connected to the popularity of 2/1 and 3/1 ARM mortgages.

If you’re going to do things like install energy-efficient appliances and well-insulated windows and solar panels and so on and so forth, you’re going to worry about the cost, which will be earned back over the years in lower energy bills. If you’re not going to stay in your house for very long, you might end up negative. And there’s really no way in which a house with energy-effiencent appliances is going to be more valuable than one without them.

One of the causes/effects (I’m not sure which, it’s probably both) of the housing boom was that homeownership moved from being a decades-long thing to being something with a much shorter time horizon: often just the two years after which you could sell your house without paying capital gains tax. Parents would buy apartments for their kids to live in while going to university; newlyweds would buy houses which were too small for the families they were planning; and, especially in New York, people would buy unsuitable apartments they didn’t really like just for the sake of getting one foot onto the property ladder and the hope that they could trade up in a couple of years.

When people took out 3/1 mortgages, they didn’t worry about the resets often because they had no intention of staying in their house for the full three years. And in that kind of context, home improvements which only pay back over the long term are much less attractive: it’s the people you sell to who will get most of the benefit with none of the cost.

This is one of the pet peeves of Amory Lovins: while it makes sense from a simple economic perspective to install these energy-efficient devices, any one actor, in reality, has little incentive to do so. The plumber won’t use wide-gauge pipe because it’ll make him seem overpriced. Landlords, renters, contractors, homeowners – all end up concentrating much more on up-front costs than on net present value.

So why is the Prius a success? Well, for one thing, it isn’t, really, not outside Berkeley: it accounts for a tiny fraction of cars sold in this country, and the US as a whole has atrocious gas mileage. And it turns out that insofar as the Prius is a success, it’s a success precisely among the small class of people who don’t tend to concentrate on up-front costs. And even they won’t buy a Prius unless and until they need a new car; windows wear out much more slowly than cars do.

This is really why we need a carbon tax, or a cap-and-trade system, or some other way of using a market mechanism to somehow provide incentives to jump on to the energy-efficiency bandwagon. If there’s money in it, someone will invent a way to arbitrage people’s discount curves. And with arbitrageurs comes efficiency.

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