Sunday, April 11, 2010

Introduction: Energy and Growth

So you know where this paper is going, here is the introduction as it currently stands:


Is energy an important driver of economic growth and development and if so what factors affect the strength of the relationship between energy and growth? Toman and Jemelkova (2003) argue that most of the literature on energy and economic development discusses how development affects energy use rather than vice versa. The principal models used to explain the growth process (e.g. Aghion and Howitt, 2009) do not include energy as a factor that could constrain or enable economic growth. Economists do pay significant attention to the impact of oil and other energy prices on economic activity in the short-run and there was extensive discussion of the role of oil prices in the "productivity slowdown" that followed the oil price shocks in 1973-74 and 1980-81. Resource economists have developed models that incorporate the role of resources including energy in the growth process. But these ideas remain isolated in the resource economics field. Much of the relevant literature is outside the mainstream in what has come to be known as ecological economics.

The first section of the paper reviews basic physical principles and economic concepts that define the role of energy in economic production and growth. The premise is that gaining an understanding of the role of energy in economic growth cannot be achieved without first understanding the role of energy in production. The principal finding is that criticism of the mainstream theory of economic growth on the basis of the implications of thermodynamics for economic production and growth is legitimate. A theory of economic production and growth must take the essential role of energy into account. On the other hand, theories that try to explain everything on the basis of energy, while ignoring the roles of information, knowledge, and institutions are similarly misguided.

However, institutions also affect how these roles play out and, therefore, the mainstream theory of economic growth, which focuses on these considerations, is reviewed next. The limitations of neoclassical theory’s consideration of energy and other resource issues have been the subject of strong criticism grounded in the biophysical theory of the role of energy. We discuss these criticisms and alternative ecological economics views on energy and growth in the following section. These criticisms focus primarily on limits to substitution and technological change. I present for the first time a theory that rigorously embeds energy use in a mainstream economic growth model. This shows that when energy is scarce it will strongly constrain economic growth, but when energy becomes more abundant energy is much less of a limiting factor and the neoclassical model explains economic growth fairly well.

In the period since 1973 significant reductions in energy intensity have been achieved in many developed and some developing countries. In some countries, energy intensity has declined over a much longer period (Gales et al., 2007). I use the production function concept to examine the factors that could reduce or strengthen the linkage between energy use and economic activity over time. These key factors are:

– substitution between energy and other inputs within an existing technology,
– technological change,
– shifts in the composition of the energy input, and
– shifts in the composition of economic output.

Each of these themes has a subsection dedicated to its discussion. Following this, I review the empirical evidence on the causal link between energy and growth. To be useful, such studies must not be grounded in a single theory, potential mechanism, or school of thought. Therefore, the studies reviewed here are reduced form time series models that do not specify structural linkages between energy and output. As correlation and regression analysis does not imply causality from one variable to another, most of these studies employ the econometric notions of Granger causality and cointegration to test the presence of and direction of causality between the variables.

The final section of the paper presents conclusions and points to implications for energy and environmental policy.

Aghion, P. and P. Howitt (2009) The Economics of Growth, MIT Press, Cambridge MA.
Gales, B., A. Kander, P. Malanima, and M. Rubio (2007) North versus South: Energy transition and energy intensity in Europe over 200 years, European Review of Economic History 11: 219-253.
Toman, M. A. and B. Jemelkova (2003). “Energy and economic development: an assessment of the state of knowledge.” Energy Journal 24(4): 93-112.

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