Chapter I. Introduction
Chapter 5. Policy proposals for the introduction of Top-runner system introduction of Top-runner system
In this chapter, taking into consideration earlier discussed Japanese operation cases, success factors and the problem s exam ined through som e theoretical m odels, w e w ill look through m ajor considerations for the introduction of Top-runner system in K orea. The m ost im portant thing in operating the system is how to select target products and target periods. If target products and target periods are w rongly decided, som e serious problem s like tacit collusion is m ore likely to occur. O n the other hand, for all the m erits Top-runner system has, the system on its ow n has lim its in attaining the policy objective of im proving energy efficiency. Therefore, there needs to be a synergy betw een Top-runner schem e and other com plem entary system s.
In this view , w e w ill discuss below som e policy proposals for the proper introduction of Top-runner system in K orea.
The Japanese cases and the theoretical m odels discussed
earlier suggest som e im plications to consider w hen w e select target products.
First, as D alen(1998) show s, under the yard-stick com petition regulation, individual com panies have an incentive to reduce their investm ent because they cannot be com pensated for their externality in the m arket, though their investm ent gives positive externality to other com peting com panies, that is they cannot internalize their positive externality. G enerally, the products w hose production technology can be easily recognised and follow ed, so can be easily reverse engineered, have relatively greater spillover effects. So, if Top-runner schem e are applied to such a group of products, the schem e m ay be ineffective in inducing energy efficiency technology innovation.
By contrast, if the com panies can appropriate all the benefits w hich w as created by the efficiency im provem ent follow ing their investm ent, they have an incentive to increase their investm ent.
In other w ords, the m ore appropriability of econom ic benefits ow ing to efficiency im provem ent there is, the m ore incentive to investm ent they have. Therefore, to attract investm ents m ore effectively, one should designate the products having less spillover effects across the industry as target products.
O f course, it m ay be difficult to differentiate exactly the externality of technical innovation by group of products.
H ow ever, the debates on the relationship betw een spillover
effects of technical innovation and their incentives to investm ent have an im portant im plication for the G overnm ent's R & D policy.
The introduction of Top-runner system based on Y ardstick com petition can prevent individual com panies from developing a certain type of technical innovation im proving energy efficiency across the industry. So, it is necessary to com bine the Top-runner system w ith governm ent support for R & D w hich can induce technical innovation affecting the entire industry. This is also to em phasize the necessity of governm ent support for generic technology R & D . The reason is that generic technology innovations bring about benefits such as cannot be appropriated by individual com pany. Therefore, in order that Top-runner system m ay be effective, there needs to be a support for the technical innovation affecting positively the entire group of products(otherw ise, investm ent in innovation in this sector w ill be shrunken), w ith close consideration of the technical characteristics of the target products.
Second, if there are only a sm all num ber of com panies w ho produce the target products and their m arket shares are very high, the possibility of tacit collusion betw een them w ill be high.
O n the contrary, if there are a large num ber of com panies and the m arket shares of each com panies are sm all, the possibility of tacit collusion w ill be reduced. It's because the m ore the num ber of com panies participating in the m arket is, the m ore difficulty
they have in reaching an agreem ent to unify their actions(i.e. the coordinations related to tacit collusion are likely to fail). A nd, the sm aller the m arket shares of each com panies are, the less the additional econom ic benefits the individual com panies attain through the tacit collusion restricting technical innovation. So, it is also necessary to consider the num ber of participating com panies and their m arket shares in selecting target products19).
Third, as w e discussed in the section about the success factors for the Japanese Top-runner, it is necessary to consider the possibility of trade dispute in selecting the target products. If Top-runner system has a considerable effect on related overseas exporters, then the overseas exporters can regard the system as a new non-tariff trade barrier and look at a W TO dispute, even to cause international trade disputes. Especially, in a situation w here bilateral trade liberalization such as K ore-EU and K orea-U S Free Trade A greem ents has been actively im plem ented, it w ill be necessary to exam ine the possibility of international trade disputes in advance of the introduction of Top-runner system .
In this view , it m ay be a desirable option to apply the Top-runner schem e firstly to the products for w hich dom estic com panies have the highest m arket share. In Japan, dom estic com panies' m arket shares for m ost of the target products have been so high that the participants in the schem e could avoid international trade disputes, w hich constitutes a success factor for the Japanese Top-runner. B ut, it is not likely to continue that the schem e is applied only to the products for w hich dom estic com panies have high m arket shares. It's because there can be com plaints about unfair treatm ent and the current m arket shares of dom estic com panies w ill change dynam ically as the Free Trade A greem ents expand. So, it is necessary to m ake an effort so that the m easurem ent m ethods of energy efficiency and the efficiency goals m ay m easure up to international standards.
B asically, the relationship betw een regulators and regulated com panies is m aintained in the dynam ic process. The regulated com panies used to decide their current actions w ith considering the possibility of dynam ic change in regulator's behaviors. U nder Top-runner system , regulated com panies are given a certain period of tim e(target period) needed to achieve a specific goal, and the next period and the goal are determ ined on the basis of the perform ance of the previous period. O w ing to such a
dynam ic relationship, as discussed earlier, there is concerns about the inefficiency due to ratchet effects.
U nder Top-runner system , the target period is related to the ratchet effect. The shorter the target period is, the greater there is the incentive for the com panies not to reveal their potential for energy efficiency im provem ent for fear that the regulator should reinforce the regulation in the next period. In other w ords, the shorter the target period is, the faster the inform ational rents ow ing to asym m etric inform ation m ay be dissipated. Therefore, in the view of ratchet effect, it is not desirable to determ ine the target period to be too short.
O n the other hand, the target period is also related to the collusive incentive of the regulated com panies. The shorter the target period is, the less the probability of staying in the top-runner position achieved by technical innovation in the long-run is. This m eans that the expected econom ic benefit resulting from deviation from the collusion is reduced and the regulated com panies have m ore incentive to collude.
If the target period is too short, the possibility of ratchet effect and of tacit collusion w ill be so great that the effectiveness of the system m ay be reduced. In contrary, if the target period is too long, the com panies w ill have little incentive to develop energy efficiency technology. So, it is desirable to set the target period neither too short nor too long. In Japan, though varying
am ong different products, the target period has been set at the level of three to seven years.
B esides, the technical characteristics of products are also an im portant factor to consider in setting an optim al target period.
For instance, the pace and the perspective of technological progress, principal indices to evaluate technological potentials, w ill provide an im portant guideline to set the target period. The characteristics of product m arket such as the degree of product differentiation and the m arket structure can also have an influence on the decision on the optim al target period. In the end, the target period should be determ ined so as to m inim ize the possibility of ratchet effect and of tacit collusion, in consideration of the technical and m arket characteristics of target products20).
A s m entioned earlier repetitively, Top-runner system has a w eakness in allow ing tacit collusion in w hich the regulated com panies abstain from technical innovation for energy
efficiency im provem ent. W e can figure out an absolute perform ance evaluation system as a com plem entary schem e to alleviate the problem s of the regulatory system based on relative perform ance evaluation such as tacit collusion. It's because an efficiency reduction resulting from the collusion in a relative perform ance evaluation system can be som ew hat com pensated for by the regulation based on absolute perform ance index.
For exam ple, let's consider a case w here regulated com panies can m ake less effort than optim al level through their collusion under yard-stick com petition regulation. In this case, even if the absolute efficiency level of a certain product is low , it can be selected as top-runner product because the top-runner position is determ ined on the basis of relative efficiency of products, w hich can provide consum ers w ith distorted inform ation. B ut, if the governm ent applies absolute standards as w ell as Top-runner standards and provides consum ers w ith inform ation about the absolute efficiency of products, the problem arising from tacit collusion w ill be considerably alleviated.
In this context, the "energy efficiency grade system " is currently in force in K orea to provide consum ers w ith inform ation on absolute efficiency of products. The energy efficiency grade system is a typical M inim um Efficiency Perform ance Standards regulation based on absolute perform ance index in w hich m ajor dom estic appliances and
passenger cars are assorted into five grades according to their energy efficiency or energy consum ption and each product is labelled w ith its grade. This system can be utilized as a useful com plem entary regulatory schem e to Top-runner system21). This system also enables consum ers to obtain reliable inform ations on energy efficiency, providing inform ation on absolute efficiencies as w ell as relative efficiencies of the products.
B ut, as w e know it in the Japanese operating cases, the target products in Top-runner system are classified into a greater num ber of item s according to their technical characteristics or other standards22). So, it is necessary to subdivide the existing 5 grades of the energy efficiency grade system so that the connection betw een the grade system and the Top-runner system m ay generate a significant synergy effect. It is also necessary to m aintain consistency betw een the tw o system s by an integrated operation of them .
Thanks to a theoretical inquiry into Top-runner system in the
previous chapter, w e can find that the possibility of tacit collusion am ong regulated com panies m ay be reduced through a proper rew ard schem e. A n appropriate pecuniary com pensation to the Top-runner com panies can reduce their collusive incentive because it w ill increase econom ic benefits w hich can be achieved in case of deviation from the collusion.
A rew ard schem e for energy efficiency im provem ent effort can be designed in tw o w ays as follow s, depending on w ho the beneficiaries are. The first is to design an incentive schem e, focusing on Top-runner com panies. In other w ords, the schem e is designed so that the rew ard for energy efficiency im provem ent m ay be aw arded to the com panies them selves. The theoretical m odel review ed in the previous chapter show s that a direct com pensation to the com panies can induce a com petition for efficiency im provem ent. The direct com pensation schem e applied to the Top-runner com panies can be designed in the follow ing m anner.
First of all, a tax reduction program such as tax deduction only for the Top-runner com panies' investm ent in energy efficiency can be im plem ented. W e can also support R & D subsidies for the Top-runner com panies. A nother one is to design a rew ard schem e in relation to the governm ent's public procurem ent program s, instead of direct pecuniary com pensation paym ents. In Japan, the Top-runner system has been operated in
connection w ith the governm ent's public procurem ent program of green products(the G reen Procurem ent). To lim it the eligibility to be procured to the top-runner products can be also an indirect rew ard schem e for the com panies23). To aw ard a prize(com pensation) to the highest efficient product of all the top-runner products can be also a good incentive for the com panies. In Japan, the Energy Efficiency A w ards Program in w hich the highest efficient product is aw arded a governm ent's com pensation is being im plem ented. W e need to use the program as a benchm ark. In addition to the com pensation paym ent to the highest efficient product of all the top-runner products, a certificate attesting the highest efficiency of the product concerned can be issued. Such a certification system can increase consum er's aw areness of the product and of the producing com pany's energy efficiency im provem ent efforts, w hich can lead eventually to a rise in sales thanks to the reputation. B ut, the overissue of certificates as in case of the certification of venture com panies in K orea w ill reduce confidence in the certification system . So, it is necessary to verify exactly the perform ances and to restrict tightly the qualification for the aw ard so that the aw ard m ay be honored and the consum ers m ay be provided accurate inform ations about the energy efficiency of related products.
Secondly, w e can im agine an incentive schem e focusing on consum ers rather than com panies. A n incentive can be given to consum ers w ho purchase the products satisfying the Top-runner standards. So, the sale of Top-runner products w ill increase so that the com panies satisfying the Top-runner standards can be com pensated even indirectly. The eventual objective of Top-runner system lies in im proving the energy efficiency of end user products. If the direct com pensation to Top-runner com panies can't lead to actual consum er purchasing activities, Top-runner system w ill lose its prim ary reason of being. So, indirect com pensation schem es m ay be m ore effective than direct com pensation. A com pensation schem e in the stage of consum er purchasing can induce an actual increase of sales, contributing to the objective of Top-runner system , so that the com panies m aking a great effort to im prove energy efficiency can be indirectly com pensated through the m arket.
Especially, if the dem and for the product is inelastic or each com pany can som ew hat control the price of its product because it is horizontally differentiated, the com pensation schem e to consum ers can be m ore effective than the direct com pensation to com panies. G enerally, only the price or the energy efficiency is not the criteria of consum er choice. B rand reputation, cooperation w ith parts providers, quality of after-sales services, differentiated design, etc. are also im portant criteria of consum er
choice. In case that, like above, the criteria of choice are diverse and each com pany has a certain price control as its product has a com petitive advantage in its ow n area, the direct com pensation to com panies is likely to lead to som e problem s as follow s.
Provided dem and for products is inelastic and horizontal differentiation is great enough, the direct incentive schem e for producers can reduce consum er benefits but increase producer benefits. It's because producers can recover a considerable part of their investm ent costs for energy efficiency im provem ent, by raising the price of their products. In this case, not only the com panies can recover m ost of the investm ent cost by raising the price, but also they can enjoy an additional benefit accrued by the direct com pensation. In reverse, the consum ers w ill be deprived of their avoided energy cost accrued by using energy efficient products because of the price increases. In addition, they w ill experience an additional loss of consum er surplus because of the direct com pensation to the com panies through the tax. This may lead to a decrease in demand for Top-runner products and finally impair the effectiveness of Top-runner system.
Therefore, incentive schem es should be designed in consideration of dem and conditions and com petitive structure in the m arket. If the products concerned are relatively hom ogeneous and the prices are the m ost im portant source of the com panies' com petitive advantage, the com panies w ill have difficulty in recovering the cost of investing in energy efficiency
im provem ent by increasing prices. In this case, the direct com pensation to the com panies m ay reduce the possibility of collusion, com pared to w hat w ould otherw ise happen. B ut, if the products are sufficiently differentiated, the possibility of collusion can increase24). The reason is that if the investm ent cost for energy efficiency im provem ent is great, the com panies w ill have m ore collusive incentive because the additional benefit resulting from the deviation from the tacit collusion is restricted by horizontal differentiation or because the com panies producing Top-runner products cannot greatly enlarge their m arket share only by m eans of producing m ore efficient product. So, as in the case that the products are hom ogeneous, it is necessary to com plem ent a rew ard schem e to reduce the possibility of collusion. B ut, in that case, as Top-runner com panies can relatively easily pass their cost onto consum ers, the com pensation to consum ers w ill be m ore effective than the direct com pensation to producers.
R ecent related studies in overseas confirm s this opinion.
A ccording to a survey based on interview s w ith auto industry experts, conducted by the Sw edish Environm ent O ffice, som e experts think sm all scale tax cut program s in the stage of final consum ption are m ore effective than direct com pensation to particular com panies w hich have developed the highest technology for energy efficiency(The Sw edish Environm ent Protection A gency, 2005).
Then, w hat are the options for com pensation to consum ers?
Tax relief w ill be the m ost representative com pensation schem e for consum er. For exam ple, w e can consider the value-added tax reduction or the increased tax credit for consum ers purchasing top-runner products. It is also possible to induce the purchase of top-runner products, providing consum ers w ith easily usable coupons in proportion to the am ount of purchase. If this option is properly connected w ith the current Carbon C ash-back System in force, there w ill be a considerable synergy effect.25)
W e can consider an incentive schem e for distributors.
A ctually, it's distributors that provide inform ations about the m ain Top-runner target products such as refrigerator, TV set and autom obiles and that persuade consum ers to purchase the