Moral Hazard and the Energy Efficiency Gap: Theory and Evidence

We investigate how moral hazard problems can cause suboptimal investment in energy efficiency, a phenomenon known as the energy efficiency gap. We focus on contexts where the quality offered by the energy efficiency provider is imperfectly observable. We formalize underprovision of quality and compare two policy solutions: energy-savings insurance and minimum quality standards. We then provide empirical evidence of moral hazard in home energy retrofits in Florida. We find that for those measures, the quality of which is deemed hard to observe, realized energy savings are subject to day-of-the-week effects. Specifically, energy savings are significantly lower when those measures were installed on a Friday—a day particularly prone to negative shocks on workers’ productivity—than on any other weekday. We finally specify a model to simulate the Floridian market and find that the deadweight loss from moral hazard is about twice as large as that due to associated carbon dioxide externalities.