Are we literate enough to choose a new washing machine?

Economists claim that there is a so-called “energy efficiency gap”. What they mean is that many households do not invest in new and more energy-efficient appliances, although this would be financially beneficial for them. In other words: every day millions of people do not see and pick the low hanging fruits of energy-efficiency improvements growing along their way. Several possible explanations have been considered for the existence of the “energy-efficiency gap”, among them various market and behavioural failures such as missing information, liquidity constraints, subjective discount rates and risk aversion, just to name a few. Another possible reason for people to not see and pick the low-hanging fruits is associated with the lack of a specific form of literacy.

Choosing a new washing machine is a demanding task

In order to choose between two washing machines with the same functionality, a rational, utility-maximizing consumer should choose the one that minimizes lifetime cost (i.e. the sum of purchase price and future energy costs). This optimization requires both specific knowledge (e.g. of the purchase prices of the two machines, their electricity consumption, their expected lifetime, the expected intensity and/or frequency of use, as well as current and future electricity prices) and specific skills, which include the ability to calculate the lifetime cost of the two machines. However, from the theory of “bounded rationality” we know that most individuals have limited capacities to process information and therefore often fail to make optimal decisions based on rational calculations. Instead, many individuals use simple rules of thumb when making their choices.

The concept of energy-related financial literacy

We define the level of knowledge and cognitive abilities that consumers need to have in order to take investment decisions related to energy consumption as “energy-related financial literacy”. So far, the academic literature has not developed a common concept of literacy in the context of energy-related investment decision making in the residential sector. An established stream of literature (DeWaters and Powers 2011/2013) has used a definition of “energy literacy”, that focuses on an individual’s energy-relevant knowledge, attitudes and behaviour and not on economic and financial dimensions of the decision process. Recent empirical literature define and measure “energy literacy” merley as an individual’s ability to calculate and compare lifetime costs of energy consuming durables (Brounen et al. 2013, Kalmi et al. 2017). The concept of “energy-related financial literacy” we propose combines both the energy-relevant knowledge and the skills to perform an investment calculation that households need to take informed decisions with respect to energy.

Households with high levels of energy-related financial literacy make wise decisions

Recent research in Switzerland supports the relevance of energy-related financial literacy in the context of energy-related decision making of households: more literate households are more likely to tap the savings potentials in their homes. The results of an online experiment show that individuals with a higher level of energy-related financial literacy are more likely to perform an investment calculation rather than using a rule of thumb when comparing two appliances (Blasch et al. 2017b). Consequently, these individuals are much more likely to identify the appliances with the lowest lifetime cost. Another study in Switzerland showed that individuals with higher energy-related investment literacy also live in households with an overall lower energy consumption (Blasch et al. 2017a).

How to improve energy-related financial literacy?

Knowing all this, what should policy makers do? Research suggests that they should put energy education higher on their agendas and support households’ decision-making, for example with easy-to-access online tools. Individuals with access to an online calculator that helps them to compare the lifetime cost of two appliances are 12-17 percentage points more likely to identify the appliance with the lowest lifetime cost (Blasch et al. 2017c). Thus, enhancing individuals’ energy-related financial literacy would bring us one step further towards a world in which consumers are empowered to see and pick the low-hanging fruits growing along their way.

This text was written by Julia Blasch, Nina Boogen, Claudio Daminato and Massimo Filippini