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Energy Conservation Policy in Developing Countries: The Case for Market Solutions

R.W. Bates

July 1991

R.W. Bates, July 1991

Interest in energy conservation, although to some degree cyclical, has been stimulated during the last twenty years by the rising cost of energy in a wide range of developing and developed countries, especially following the oil price shocks of 1973-1974 and 1979-1980; by environmental concerns, notably due to the impact of increasing energy consumption on global warming, pollution, forests and natural habitats; and by national security considerations, as domestic energy supplies continue to be vulnerable to political events in the Middle East. An active debate has ensued, in which it is alleged that the existence of a variety of market failures, imperfections and distortions justifies government intervention in energy markets to promote expenditures on energy conservation.

It is the purpose of this paper to evaluate the validity and relevance of that debate to developing countries, in terms of demand-side management, mainly where the public sector exerts control over a significant portion of energy supply; and where that supply is sold predominantly in markets subject to consumers acting competitively. The central tenet of the paper is that confusion in the debate can only be avoided if a careful distinction is maintained between arguments related to the proper functioning of energy markets, on the hone hand; and externalities, on the other.

On the basis of a review of the literature on the sources of possible market failures and the proposed remedies, much of which was inspired by circumstances in the U.S.A., the paper finds that evidence of significant market failures sufficient to justify government intervention in energy markets is not convincing; and that the proposed remedies in any case are inappropriate. The paper concludes that, while environmental externalities may provide grounds for carefully-targeted public sector intervention in energy markets, the national security argument is hard to sustain in developing countries; and market imperfections and distortions generally do not justify non-price intervention, with the possible exception of information provision and support for basic research and development.

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