Could easier credit speed the adoption of energy efficiency?

Martin Daks | Sep 29, 2020

In the fight against climate change, low- and middle-income countries are crucial, as experts predict they will drive the growth of global energy demand.

But residents there aren’t widely adopting energy-efficient technologies, and research by Wharton’s Susanna B. Berkouwer and Chicago Booth’s Joshua Dean explores several potential reasons for this. They find one to be particularly important: access to credit.

The researchers conducted a field experiment in Nairobi, Kenya, where much of the low-income population prepares daily meals over inefficient, smoky cookstoves that burn charcoal. For the households that participated in the study, these stoves accounted for much of their energy consumption, and 14 percent of the median family income went to purchasing charcoal. The population also pays a large health cost. According to the World Health Organization, close to 4 million deaths a year are attributable to household indoor air pollution. 

There is a better option: newer, more-efficient stoves. Because they are insulated and direct heat more efficiently, the stoves consume less fuel and emit less smoke. The choice to switch to these seemed obvious, but what kept people from doing so?

To find out, Berkouwer and Dean invited 1,000 low-income families using the traditional charcoal cookstoves to participate in their study, and randomly assigned subsidies that reduced the purchase price of the more-efficient stove. A charcoal stove costs between $2 and $5, and the more-efficient one costs $40 without any subsidies.

Participants had to bid on the stove before learning the subsidized cost, and they had an incentive to submit an honest bid: If their bid was higher than the subsidized cost, they paid the lower cost for the new stove. If their bid was lower, however, they continued using their charcoal stove. 

The new stove slashed a household’s energy costs by an average $120 a year, the researchers estimate. That’s a 300 percent average annual return rate, or around one month of income. Yet families were only willing to pay $12, on average, for the more-efficient stove. 

Few would lay out the funds for the better stoves even when it was clear that the marginal benefit exceeded the marginal cost. The researchers had some families complete an accounting exercise making clear the potential savings, but that didn’t change participants’ behavior, which suggests households were already aware of the savings potential. 

However, an offer of credit did move the needle. Berkouwer and Dean randomly offered some participants a three-month loan, while the rest had to pay for a new stove up front. When they had access to a loan, participants were willing to pay $25 for the stove, more than double their original average. 

Could these results explain why some households in higher income countries don’t want to shell out extra money for cleaner energy options such as solar or geothermal? Don’t jump to that conclusion quite yet, says Dean. In the United States, an investment in solar can take years to recoup, whereas in Kenya the better stove quickly paid for itself. But even with this being the case, the participants couldn’t pay the full amount, which was more than the median weekly household income. They demonstrated a willingness to pay four times the amount they were already paying for a stove, but they simply couldn’t afford the full amount without credit. 

The findings demonstrate the crucial role that credit can play, but also the danger in exporting energy policies from high-income countries to the rest of the world, says Dean. A policy such as a carbon tax may tip the scales for a US resident considering the switch to cleaner energy. But for a poor resident of Kenya, who already wants to make that switch, the scales are already tipped and the issue may be access. In this case, subsidies or loans for high-return, energy-efficient technologies could improve environmental outcomes, save poor households money, and benefit public health. 

Many participants reported using the savings for critical household expenses such as food and school fees. “This means governments looking to reduce poverty by increasing household adoption of profitable technologies may find that addressing market failures in the credit sector can provide tangible opportunities for welfare gains for poor households,” the researchers write.