How Accurate are Projections of Energy Intensity?

A new short working paper about how accurate projections of future energy intensity are. It's an extension of comments I made at Energy Update 2016 here at the ANU.

Energy intensity is one of the four factors in the Kaya Identity, which is often used to understand changes in greenhouse gas emissions. It is one of the two most important factors together with the rate of economic growth. The 2014 IPCC Assessment Report shows that less than 5% of models included in the assessment project that energy intensity will decline slower than the historic rate under business as usual:*

Is this likely? In the paper, I evaluate the past performance of the projections implied by the World Energy Outlook (WEO) published annually (except in 1997) by the International Energy Agency (IEA). The following graph shows the average annual difference between the projected and actual rate of change in energy intensity in subsequent years** for each WEO since 1994:

Positive errors mean that energy intensity declined slower than projected in the following years while negative errors mean it declined faster. So, for example, the error of -0.4% for 2000 means that over the years 2001-2015, on average energy intensity declined by 0.4% a year faster than was projected in the 2000 WEO.

It turns out that these errors are strongly negatively correlated (r = -0.8) with the error in projecting the rate of economic growth, which IEA outsources. Csereklyei et al. (2016), similarly, find that reductions in energy intensity tend to only occur in countries with growing economies. If we divide and multiply the growth rate of energy intensity g(E/Y) by the growth rate of GDP g(Y) we get the following identity:

The first term on the right hand side can be seen as the elasticity of energy intensity with respect to GDP.*** The following graph plots the elasticity as projected and as subsequently realized for each WEO:

The two seem to have tracked each other quite well. But there is a complication. The 1994 to 96 WEOs only projected future energy use up to 2010. 2010 is the only recent year when global energy intensity actually increased. This end point reduces (in absolute value) the actual elasticities for these three WEOs. From 1998 on, the difference between the projected and actual rate of change in energy intensity is calculated up to 2015. But through the 2011 WEO, 2010 is one of the years in the projection period. From 2012, 2010 is no longer include in the projection period and there is a sharp step down in the actual elasticity over the projection period. I think that the elasticities for 2012-16 probably under-estimate the true long-run elasticities and that the relatively stable values from 1998-2011 are more representative of what the future elasticities will be over the full projection horizon to 2030 or 2040.

If that is the case, then the projected elasticity of -0.6 in the 2016 WEO probably over-estimates the the elasticity that will be realized in the long run. Why would this be the case?

Early WEOs largely modeled energy intensity trends based on historical trends. This is not the case for recent WEOs. Over time, the IEA has endogenized more variables in their model of the world energy system and included more and more explicit energy policies. It is likely that the model under-estimates the economy-wide rebound effect. It's also possible that energy efficiency policies are not implemented as effectively as expected.

As part of our ARC funded DP16 project, we hope to contribute to improving future projections of energy intensity by empirically estimating the economy-wide rebound effect.

* The light grey area indicates the projections between the 95th and 100th percentile of the range for the default scenario.

** The base year for each WEO is 2-3 years before the publication date. Therefore, we can already assess the 2015 and 2016 WEO's.

*** We can use the identity to decompose the projection errors:

Over time the contribution of errors in the projected growth rate has increased relative to the contribution from errors in the elasticity. But I think that if we revisit this experiment in 2030 we will find a larger contribution from errors in the elasticity for what are currently recent issues of the WEO.

P.S. 23 June 2017

The paper is now published in Climatic Change.

Traditional Views, Revisionist Views, and Counter-revisionist Views on the Industrial Revolution

Following up on my post on our paper about the Industrial Revolution , I thought some more context would be useful. The traditional view of the Industrial Revolution was that the availability of resources of coal, iron ore, and earlier water power in Britain were crucial factors that lead to the Industrial Revolution occurring in Britain and not elsewhere. Of course, these weren't sufficient - industrialization didn't happen in China - and so institutions also seemed to be important. But in recent years economists have emphasized the role of institutions and downplayed the role of resources more and more. This is what I call the revisionist view. Tony Wrigley and Robert Allen are key exponents of a counter-revisionist view, reemphasizing the role of resources, though not ignoring the importance of institutions. Our paper is a mathematical and quantitative exploration of the counter-revisionist view.

Economists and historians are divided on the importance of coal in fueling the increase in the rate of economic growth in the Industrial Revolution. Many researchers (e.g. Wilkinson, 1973; Wrigley, 1988, 2010; Pomeranz, 2000; Krausmann et al., 2008; Allen, 2009, 2012; Barbier, 2011; Gutberlet, 2012; Kander et al., 2013; Fernihough and O’Rourke, 2014, Gars and Olovsson, 2015) argue that innovations in the use, and growth in the quantity consumed, of coal played a crucial role in driving the Industrial Revolution. By contrast, some economic historians (e.g. Clark and Jacks, 2007; Kunnas and Myllyntaus 2009) and economists (e.g. Madsen et al., 2010) either argue that it was not necessary to expand the use of modern energy carriers such as coal, or do not give coal a central role (e.g. Clark, 2014).

Wrigley (1988, 2010) stresses that the shift from an economy that relied on land resources to one based on fossil fuels is the essence of the Industrial Revolution and could explain the differential development of the Dutch and British economies. Both countries had the necessary institutions for the Industrial Revolution to occur but capital accumulation in the Netherlands faced a renewable energy resource constraint, while in Britain domestic coal mines in combination with steam engines, at first to pump water out of the mines and later for many other uses, provided a way out from the constraint. Early in the Industrial Revolution, the transport of coal had to be carried out using traditional energy carriers, for instance by horse carriages, and was very costly, but the adoption of coal-using steam engines for transport, reduced the costs of trade and the Industrial Revolution spread to other regions and countries.

Pomeranz (2001) makes a similar argument, but addresses the issue of the large historical divergence in economic growth rates between England and the Western World on the one hand and China and the rest of Asia on the other. He suggests that shallow coal-mines, close to urban centers together with the exploitation of land resources overseas were very important in the rise of England. “Ghost land”, used for the production of cotton for the British textile industry provided England with natural resources, and eased the constraints of the fixed supply of land. In this way, England could break the constraints of the organic economy (based on land production) and enter into modern economic growth.

Allen (2009) places energy innovation center-stage in his explanation of why the industrial revolution occurred in Britain. Like Wrigley and Pomeranz, he compares Britain to other advanced European economies of the time (the Netherlands and Belgium) and the advanced economy in the East: China. England stands out as an exception in two ways: coal was relatively cheap there and labor costs were higher than elsewhere. Therefore, it was profitable to substitute coal-fuelled machines for labor in Britain, even when these machines were inefficient and consumed large amounts of coal. In no other place on Earth did this make sense. Many technological innovations were required in order to use coal effectively in new applications ranging from domestic heating and cooking to iron smelting. These induced innovations sparked the Industrial Revolution. Continued innovation that improved energy efficiency and reductions in the cost of transporting coal eventually made coal-using technologies profitable in other countries too.

By contrast, Clark and Jacks (2007) argue that an industrial revolution could still have happened in a coal-less Britain with only "modest costs to the productivity growth of the economy" (68), because the value of coal was only a modest share of British GDP, and they argue that Britain's energy supply could have been greatly expanded, albeit at about twice the cost of coal, by importing wood from the Baltic. Madsen et al. (2010) find that, controlling for a number of innovation related variables, changes in coal production did not have a significant effect on labor productivity growth in Britain between 1700 and 1915. But as innovation was required to expand the use of coal this result could make sense even if the expansion of coal was essential for growth to proceed. Both Clark and Jacks (2007) and Madsen et al. (2010) do not allow for the dynamic effects of resource scarcity on the rate of innovation. Tepper and Borowiecki (2015) also find a relatively small direct role for coal but concede that: “coal contributed to structural change in the British economy” (231), which they find was the most important factor in raising the rate of economic growth. On the other hand, Fernihough and O’Rourke (2014) and Gutberlet (2012) use geographical analysis to show the importance of access to local coal in driving industrialization and urban population growth, though Kelly et al. (2015) provide contradictory evidence on this point. Finally, Kander and Stern (2014) econometrically estimate a model of the transition from biomass energy (mainly wood) to fossil fuel (mainly coal) in Sweden, which shows the importance of this transition in economic growth there.

Our new paper shows that the switch to coal in response to resource scarcity is a plausible explanation of how an increase in the rate of economic growth and a dramatic restructuring of the economy could be triggered in a country with a suitable environment for innovation and capital accumulation. We argue that in the absence of resource scarcity this shift might not have happened or have been much delayed.

References

Allen, Robert C. 2012. "The Shift to Coal and Implications for the Next Energy Transition." Energy Policy 50: 17-23.

Barbier, Edward .B. 2011. Scarcity and Frontiers: How Economies Have Developed Through Natural Resource Exploitation. Cambridge University Press: Cambridge and New York.

Clark, Gregory. 2014. “The Industrial Revolution.” In Handbook of Economic Growth, Vol 2A, edited by Philippe Aghion and Steven Durlauf, 217-62. Amsterdam: North Holland.

Clark, Gregory, and David Jacks. 2007. “Coal and the Industrial Revolution 1700-1869.” European Review of Economic History 11: 39–72.

Fernihough, Alan, and Kevin Hjortshøj O’Rourke. 2014. “Coal and the European Industrial Revolution.” NBER Working Paper 19802.

Kander, Astrid, Paolo Malanima, and Paul Warde. 2014. Power to the People – Energy and Economic Transformation of Europe over Four Centuries. Princeton, NJ: Princeton University Press.

Kander, Astrid, and David I. Stern. 2014. “Economic Growth and the Transition from Traditional to Modern Energy in Sweden.” Energy Economics 46: 56-65.

Kelly, Morgan, Joel Mokyr, and Cormac Ó Gráda. 2015. “Roots of the industrial revolution.” UCD Centre for Economic Research Working Paper WP2015/24.

Krausmann, Fridolin, Heinz Schandl, and Rolf Peter Sieferle. 2008. “Socio-Ecological Regime Transitions in Austria and the United Kingdom.” Ecological Economics 65: 187-201.

Madsen, Jakob B., James B. Ang, and Rajabrata Banerjee. 2010. “Four Centuries of British Economic Growth: the Roles of Technology and Population.” Journal of Economic Growth 15(4): 263-90.

O’Rourke, Kevin Hjortshøj, Ahmed S. Rahman and Alan M. Taylor. 2013. “Luddites, the Industrial Revolution, and the Demographic Transition.” Journal of Economic Growth 18: 373-409.

Pomeranz, Kenneth L. 2001. The Great Divergence: China, Europe and the Making of the Modern World Economy. Princeton, NJ: Princeton University Press.

Tepper, Alexander, and Karol J. Borowiecki. 2015. “Accounting for Breakout in Britain: The Industrial Revolution through a Malthusian Lens.” Journal of Macroeconomics 44: 219-33.

Wilkinson, Richard G. 1973. Poverty and Progress: An Ecological Model of Economic Development. London: Methuen.

Wrigley, E. Anthony. 1988. Continuity, Chance, and Change: The Character of the Industrial Revolution in England. Cambridge: Cambridge University Press.

Wrigley, E. Anthony. 2010. Energy and the English Industrial Revolution. Cambridge: Cambridge University Press.