RSPT: Lack of Transparency is the Issue

From the point of view of the mining industry and their potential financial bankers in the banking industry there are two key issues:

1. How are existing projects where the government hasn't been accounting itself as a passive shareholder to date to be dealt with.

2. Whether the government is really going to refund losses in the event of a project failing. The miners and banks are saying they place no value on this guarantee and, therefore, no-one will lend to mining projects at the long-term government bond rate. Here, there are two sub-issues. One is that it seems highly likely that the government would do a backflip in the future and in the event of a recession that resulted in many mining projects going under, refuse to hand over billions in tax refunds to "rich foreign mining companies". Rudd's rhetoric on the RSPT suggests that this is a real risk. Second, there is a lack of clarity of how the refund interacts with bankruptcy law. Will shareholder and creditors really have access to the tax refund in the case of a bankruptcy? I don't understand the details of the latter but it seems to be a real concern.

The government could assuage these latter concerns by adopting the full pure "Brown tax" by immediately refunding 40% of all costs upfront on a quarterly basis. But they don't want to do this. Obviously, they must think they gain by pushing these costs into the future rather than by funding them themselves at the government bond rate. If the government won't fund them at 6%, why should the mining and banking industries?

From the taxpayers' perspective the downside of the RSPT over royalties is the increase in the risky of government revenue that results. The Brown tax makes that explicit. Again the government would seem to be concerned about making that obvious to the public.

IPCC AR5 WGIII

The IPCC has just announced the authors for the Fifth Assessment Report, Working Group III (Mitigation of Climate Change). I am one of the selected authors and will be agreeing to participate. I will be working on a team working on Chapter 5: "Drivers, Trends, and Mitigation".

Exploratory Analysis of Chaves and Koenraadt

A couple of days ago I mentioned the Chaves and Koenraadt paper on malaria. I've looked over it a bit since but would really have to repeat the analysis myself in order to come up with anything conclusive as the time series analysis is so poorly documented. To recap, here is the temperature time series from Kericho in Kenya that they use:



One of the models they fit is the basic structural model. This model consists of a stochastic trend a seasonal component and residual noise. The stochastic trend is a local linear trend model:



Beta is a simple random walk with random error term Xi. It acts as the slope of the I(2) stochastic trend Mu which also has an additional random error term Eta. According to the paper this is what Mu looks like (I think):



The trend shows that temperature increased by about 0.08 C over the period when we remove the seasonal and noise components. Unfortunately, the authors do not provide a confidence interval in the chart and so it is hard to tell if this is a significant increase or not. But they do provide estimates of the standard deviations of eta and xi, which are 0.29 and 0.12 respectively.* Both of these are larger than the entire increase in temperature shown by the trend, suggesting that the increase is insignificant.


* They actually give the variances in the paper and these are the square roots of the variance.

CERF National Conference

In a last minute substitution I am going to be presenting instead of Regina Betz at the CERF National Conference at Old Parliament House on Tuesday at 1pm. Title will be "Modelling Global Energy Efficiency Trends". I'll try to cover both implications for Australian energy efficiency and Chinese and Indian emissions intensity targets in the 15 minutes allowed.

New Controversy on Malaria and Climate Change

For discussion of the 2011 paper in PLoS ONE see this new blog post.



Some of my coauthors on our work on malaria and climate change have an article (with others) in the latest issue of Nature. Their main point is that even if climate change has had an effect on the prevalence of malaria in the last century, that effect is swamped by everything else that has been going on. Also that the current distribution of malaria endemicity is no guide to future trends. Both these points seem pretty sensible to me but Joe Romm is outraged. He describes the authors of the paper as "sloppy" because he thinks they exaggerate the degree to which the IPCC support the "Malaria is increasing due to climate change hypothesis". This is a rather indirect criticism. He thinks the IPCC underplayed the threat and accuses them of saying the IPCC overplayed the threat. That's the best he's got against their paper... It's typical of Romm to trash a paper for extraneous reasons if it doesn't fit the global warming is always bad everywhere party line.

In passing, he notes the recent Chaves and Koenraadt paper which he quotes Science Daily as saying debunks our 2002 paper in Nature. I hadn't read it up till now, though citation tracking meant that I was aware of it. I need to do some background research before I can comment in detail on the paper. In the meantime, here is their monthly data for Kericho, Kenya:



Note that this isn't for 1966-2002 in fact despite the article claiming that that is the data they analysed. And here is the data we actually used for 1966 to 1995:



The series are not identical. In both cases the variance seems to go down a little and there does seem to be some possible increase in mean annual temperature. The question is whether it is truly statistically significant. Our answer was no, Chaves and Koenraadt suggest yes. If so, it is a very small change. People are still arguing about whether there is a significant trend in global mean temperature, where there is a much clearer trend...

More on the RSPT

I read a couple more papers on resource taxation and am not much clearer about things. Ben Smith wrote about the impossibility of a neutral resource rent tax and Diderik Lund wrote
a recent review.

It is pretty clear that a pure "Brown tax" where the mining company immediately gets refunded the tax rate (say 40%) multiplied by all losses minimizes the effect on investment decisions as long as the government is definitely going to keep on doing that. The government becomes an effective passive shareholder in 40% of each project. There is still a question of the government getting a free ride on the intangible capital/human resources of the mining company, which aren't usually expensed to individual projects. Under certainty, this would then be a neutral tax on investment.*

Further complications ensue when losses must be carried forward or some expenses are excluded. The RSPT carries forward losses at the long-term bond rate because the Henry review argues that as the government will eventually refund their share of any terminal loss the company is effectively lending money to the government. Whether this results in a tax that is still neutral in its investment effects is debatable, it appears to depend on modeling assumptions. Investors might not mind lending money to the government at the government bond rate but it is a different question to force them to do so when they have other investment opportunities. Emphasizing this point, the tax doesn't allow the deduction of interest expenses. The company's existing cost of capital is likely to be higher than the government bond rate. The Henry review lists a number of other expenses that cannot be deducted some of which seem reasonable and some not. All these variations on the pure Brown tax certainly reduce the neutrality of the tax.

I just read comments in the Australian from Ross Garnaut which further explain the reasoning behind the use of the government bond rate. If the government is promising to repay all losses then banks lending to the mining company should also be prepared to lend at the government bond rate. So, by this thinking there is no wedge between the returns on the RSPT capital account and the company's cost of capital. Garnaut is saying that this is a simplification which isn't likely to hold in reality. It certainly doesn't apply to existing projects - but accelerated depreciation is meant to deal with that issue. Shareholders will effectively put in 60% of the capital to projects and get the normal rate of return on that 60%.

I think I understand fully where the Treasury is coming from now.

* As Jerry Hausman argued after I wrote this blogpost originally things get more complicated even for this best case Brown tax when there is uncertainty.

Garnaut Says RSPT Needs More Study

Ross Garnaut says that the RSPT needs more study and analysis and that the government hasn't handled this well. Importantly, Garnaut co-authored the paper that initiated interest in such a tax.

I'm planning to produce a blogpost soon with some more discussion of the complications involved with this tax. My impression is that the authors of the Henry review did not read recent literature on the issue. But maybe I'm wrong.

Paper Accepted at Economics Letters

My paper Derivation of the Hicks, or Direct, Elasticity of Substitution from the Input Distance Function has been accepted for publication at Economics Letters. As I've mentioned before, the elasticity of substitution measures the difficulty of replacing one input to production such as energy with another such as capital, usually under the assumption that the level of output must be kept constant. This parameter is very important in the study of long-run economic growth and sustainability, the costs of climate policy, among many other areas. The traditional elasticity of substitution measured the percent change in the ratio of input quantities for a given percentage change in the ratio of their prices (or marginal products) holding output constant. The formula was derived using the production function. My paper derives the elasticity from the more general input distance function, which can have multiple outputs and can accommodate possibly inefficient production. I also show that "distance" or technical efficiency must be held constant when calculating the elasticity. This is an additional condition which was classically implicitly assumed to be the case rather than explicitly stated. This new derivation helps complete the classification of many different related elasticities.

Updated Versions of Papers

An updated version of my paper "Between Estimates of the Environmental Kuznets Curve" is now available in the CAMA Working Paper Series. Also my article "Energy Quality" has been published in Ecological Economics.

Public Policy Precinct at ANU

Lots of public policy initiatives are planned at ANU in which the Crawford School looks to play a major role:

ANU Media Release

SATURDAY 8 MAY 2010

ANU TO ESTABLISH $111.7 million PUBLIC POLICY PRECINCT

The Australian National University (ANU) will play a lead role in
boosting Australia's expertise through enhanced teaching and research in
public policy and will establish a new Australian National Institute for
Public Policy to complement the enhanced role.

The Commonwealth Government has committed a grand total of $111.7
million for this purpose.

ANU Vice-Chancellor Professor Ian Chubb said: "The importance of
teaching and research as a foundation for future policy will be
highlighted by the development of a public policy 'precinct' based
around the new JG Crawford building. We would like also to thank the
Federal Government for their commitment to education and research as a
means to build a solid foundation for Australia's future."

Announced by the Prime Minister today, the $111.7 million will cover a
number of elements:


* An Australian National Institute for Public Policy -
established to highlight under one banner the public policy expertise
available through ANU and its various specialist centres, including the
recently announced Australian Centre on China in the World and the
National Security College, and the Australia and New Zealand School of
Government (ANZSOG);

* $14 million to bolster public policy expertise at ANU, through
enhancing capacity in The Crawford School of Economics and Government
and establishing the H. C. Coombs Policy Forum, which will inform future
policy development;

* $7 million to support Sir Roland Wilson Foundation
scholarships for public servants to study at ANU;

* $17.3 million National Security College operations;

* A new $19.8 million building to house jointly the new National
Security College and the enhanced presence of ANZSOG in the precinct;

* The recently announced $53.1 million Australian Centre on
China in the World (including a building); and

* $0.5m to scope the need and nature of additional accommodation
for officials and students in Canberra for courses.


Professor Chubb said the 'precinct' would be a place where public
servants and others working on policy for the nation could engage with
leading researchers and educators from a wide range of disciplines.

"We welcome this announcement from the Commonwealth Government, and are
very pleased to see our strategic relationship with the Government
gathering such momentum," Professor Chubb said.

"Since its establishment in 1946 ANU has had very close links with
public service, whether that is through our researchers informing
Government policy or professional short courses.

"Today's announcement takes the relationship between the nation's
university, the nation's public servants and the nation's Government to
a new level. The public policy precinct is a very tangible sign that ANU
is a strategic endowment for the nation, working in the national
interest.

"The H. C. Coombs Forum will be a key part of the development, and will
be the venue for well-informed, spirited debate between academics and
public servants. It will also be the base for research-based evidence
informing public policy," Professor Chubb said.

Royalties vs. Rent Taxes

I'm now reading the Henry Review in more detail. The argument against royalties and in favor of a rent tax, which was put forward by Garnaut and Clunies Ross is based on the idea that both are taxes. Because the royalty allows no deductions for costs it acts as an incentive against development of more marginal projects that would have gone ahead in the absence of the tax. The Brown tax essentially has the government investing up front alongside the mining company by refunding 40% of losses in the early years of the project and later years too if the project fails to make a profit. The Garnaut and Clunies Ross rent tax and variants including this proposal, based on my current understanding, carry forward these losses at some rate of interest. This was theorized not to distort investment decisions, though there has been a lot of subsequent discussion of whether that is true or not.

But if we treat the government like any other landowner and the royalty as the rent (different meaning again here) it charges tenants then the royalty is no longer seen as distorting. It is just the payment required to use the asset in question. If some projects are discouraged at this point in time there might be a very good reason for that. Perhaps we as resource owners want to keep the resource in the ground for use in the future when prices are higher? I don't know if the latter is a good argument but I think that whether something is seen as an efficiency reducing distortion in economics can depend on your perspective.

If I am understanding this correctly the reason the mining industry is outraged is not the RSPT itself (which isn't a "super profits tax" at all) but the fact that the 40% tax will apply to all existing projects not just to future profits. I now understand that the government bond rate is has been chosen for carry forwards in new projects because of the view that the mining companies are effectively lending money to the government not investing in the project. The government agrees to eventually repay 40% of all losses with interest at the government bond rate even if the project fails and never makes any money.

ReSPecT

My immediate reaction to the RSPT proposal was to wonder if it will ever get through parliament as proposed and to suggest that at least the hurdle rate needed to be substantially raised. Today in the Australian, Henry Ergas discusses the "Brown tax" named after E. Carey Brown. I'll admit that I hadn't heard that term before. A quick search found a reference to this in a working paper by Ben Smith on the topic. Obviously, I need to study this further. But, would we want the ideal tax described by Ergas, where the government becomes a coinvestor on each mining project? After divesting assets such as Telstra in Australia partly because they were seen as too risky why would we want to take on the risk of investing in the mining industry?

Note that the "resource rents" referred to in this context are not the same thing as the resource rents referred to in the capital theory of sustainability. Some sort of royalty payment would seem to be the way to try to capture those, I think.

Also, see the very interesting commentary from Peter Martin.

The original proposal for the resource rent tax actually being discussed is in a paper in the Economic Journal by Ross Garnaut and Anthony Clunies-Ross in 1975.

EERH Working Paper Statistics for April 2010

This month's RePEc statistics are in. EERH saw a slight tick up in downloads, probably due to us getting more papers online. We now have 55 papers online.

It's the Economy Stupid

There is all this discussion in the UK about why the Labour Party looks set to lose the election and no-one makes the obvious point: there is (or was) a bad recession and the government has been in power for 13 years. Still it is going to be interesting what happens coalition-wise post-election. I'm a British citizen, so I have some interest I guess...

Will Today's Tax and Superannuation Proposals Actually be Implemented?

Based on the Rudd government's record to date I don't expect these "reforms" to be implemented as announced. The Liberal-National Coalition will oppose them. I expect that the Greens will like them. So, based on the current composition of the Senate, it will depend on Xenophon and Fielding and I have no idea what they'll think. Of course, the legislation would likely wait till after the election. The Henry Review argued for a normal return on capital equal to the long-term government bond rate in order to compute which part of profits are "super profits". That seems very low. It makes no allowance for a risk premium on equity. So I'd expect that rate to be raised and the tax rate possibly to be lowered if this is ever going to be enacted.

Angus Maddison Dies

Just heard that Angus Maddison died. The Economist has an obituary. I visited Gronigen a few years ago but didn't get to meet him. Just a few days ago I was checking his data on historical GDP. The work of my colleagues such as Astrid Kander and Paul Warde follows in this tradition in reconstructing the energy history of Europe.

Beyond the environmental Kuznets curve: Diffusion of sulfur-emissions-abating technology

A group of students in Sweden sent me some questions about my paper:

Stern D. I. (2005) Beyond the environmental Kuznets curve: Diffusion of sulfur-emissions-abating technology, Journal of Environment and Development 14(1), 101-124.

The paper is fairly technical and so I thought it might be useful to post my responses here.

What would you say is the main question in the framework of dematerialization in your paper?

The focus of my paper is on the reduction in sulfur emissions. I don't think the paper is mainly about dematerialization as I understand it, in particular. Within my focus on sulfur emissions I am mainly interested in changes in sulfur emissions when we hold many other things that are going on constant - what economists like to call "ceteris paribus". Now those things I am holding constant are the shift of the economy from manufacturing to services or from agriculture to industry etc. and also the shift in the mix of fuels say from coal to natural gas or from oil to electricity. Those changes will affect sulfur emissions. All of these moves may involve "dematerialization". The effects of these variables are displayed in Table 2 "Frontier parameter estimates".

What is left after controlling for those factors are the trends in Figure 2 "Emissions technology trends". Over time there has been a reduction in sulfur emissions holding all the table 2 factors constant in most countries. This results in less sulfur being emitted into the environment as sulfur dioxide but doesn't probably result in dematerialization.

What is your reasoning on how to realize this dematerialization of sulphur emissions?


One of the leading methods of sulfur abatement is flue gas desulfurization (see picture above) which reacts the gas with limestone to form calcium sulfate. This requires mining limestone, building the machinery that removes the pollutant and then disposing of the waste. And desulfurization consumes energy. In some cases the waste has been used in the building industry and so there hasn't been a big increase in material and energy used. Other approaches are using low sulfur coal and "washing coal" to remove sulfur prior to burning.


What are your personal opinions on the outcome of the paper?

The most interesting result for me was how the countries ended up grouping into two groups by 2000 - a low pollution group of Germanic/Scandinavian countries and Japan and a high pollution group of Mediterranean and Anglo Saxon countries. I didn't really expect to find that quite so clearly. Recently I realised that this seems to be related to the idea of "legal origin". French and English legal origin countries have higher pollution, ceteris paribus, and German and Scandinavian legal origin countries lower pollution. Japan's legal system is based on the German system. I also found that countries with higher per capita income, higher population density, and higher potential pollution if nothing was done about it had lower pollution ceteris paribus.

Blue and Red States and Climate Change

Source: U.S. EPA, Climate Change Indicators in the United States, April 2010.

The map above shows that there has been more climate change on average in "blue states" - those that vote Democratic than in "red states" - those that vote Republican in the US. The colors are neatly reversed (here they are the traditional blue for conservative and red for left wing). Does this partly explain the divide in US politics on climate change? But there is the same divide in Australia and to some degree in Britain. So I don't know if this has anything to do with it.

The Environment and Directed Technical Change: Acemoglu et al.

Acemoglu, Aghion, Bursztyn, and Hemous put out an interesting NBER Working Paper last October. The abstract is below. They carry out a simulation which shows that a carbon tax alone is significantly inferior in terms of loss of consumption to a combination of a carbon tax and clean technology development subsidy. Results depend on the elasticity of substitution between dirty and clean inputs and the discount rate. If the elasticity of substitution is 10 then temperature never rises by more than 1.76C irrespective of the discount rate and a carbon tax only policy costs 0.92 to 1.55% of consumption relative to the optimal policy depending on the discount rate. But lower elasticities of substitution (5 or 3) make a carbon tax worse (2-4% consumption loss) and result in catastrophic climate change (7-8C) under higher discount rates (1 to 1.5% rate of time preference, latter is Nordhaus' choice).

It is likely that the interfuel elasticity of substitution is greater than unity. But, based on my research I think it is very unlikely to be as high as 5 or 10.

Based on this research more attention should be paid to combining innovation policy with a carbon tax. This is a position that is, I believe, advocated by Roger Pielke among others. But it also shows that there can be a huge difference between using discount rates as high as 0.015% rather than the 0.001% favored by Nicholas Stern in assessing climate policy.

There is a lot more besides this in the paper including the effects of delay and non-renewable resources and the problem of global policy coordination,

Abstract
This paper introduces endogenous and directed technical change in a growth model with environmental constraints and limited resources. A unique final good is produced by combining inputs from two sectors. One of these sectors uses "dirty" machines and thus creates environmental degradation. Research can be directed to improving the technology of machines in either sector. We characterize dynamic tax policies that achieve sustainable growth or maximize intertemporal welfare, as a function of the degree of substitutability between clean and dirty inputs, environmental and resource stocks, and cross-country technological spillovers. We show that: (i) in the case where the inputs are sufficiently substitutable, sustainable long-run growth can be achieved with temporary taxation of dirty innovation and production; (ii) optimal policy involves both "carbon taxes" and research subsidies, so that excessive use of carbon taxes is avoided; (iii) delay in intervention is costly: the sooner and the stronger is the policy response, the shorter is the slow growth transition phase; (iv) the use of an exhaustible resource in dirty input production helps the switch to clean innovation under laissez-faire when the two inputs are substitutes. Under reasonable parameter values (corresponding to those used in existing models with exogenous technology) and with sufficient substitutability between inputs, it is optimal to redirect technical change towards clean technologies immediately and optimal environmental regulation need not reduce long-run growth. We also show that in a two-country extension, even though optimal environmental policy involves global policy coordination, when the two inputs are sufficiently substitutable environmental regulation only in the North may be sufficient to avoid a global disaster.

How Should We Adjust Economic Institution Rankings for Size?

RePEc provides a ranking of top level economics institutions as well as the number of authors at each institution. This ranking has been criticized online because it ranks MIT below the World Bank, NYU, and Columbia. Everyone knows that that isn't true. But how could we come up with a better ranking? If bigger institutions are better up to a point then it won't help us to either have the original data and compute a ranking on the basis of the average score of authors at those institutions. Nor will it help to use modeling approaches for ranked data to adjust the ranks for a standardized institution size.

I think it is obvious that size matters. French and Blanchflower make Dartmouth a very good economics institution for its size. On this chart:



You can see that Dartmouth is on the "frontier". So are the Minnesota Federal Reserve, Princeton, Chicago, and Harvard. MIT, Tel Aviv and UC Berkeley are just behind the frontier. But does this mean that the former 5 should be considered the top 5 quality institutions? OTOH, clearly ANU, Oxford, and the World Bank are a long way behind the quality frontier despite their size.

Energy and Growth Survey: Conclusions

We conclude that the theoretical and empirical evidence indicates that energy use and output are tightly coupled with energy availability playing a key role in enabling growth. However, the greater availability of energy, technical progress, and the employment of higher quality fuels has allowed less energy to be used per unit output and has reduced the constraint that energy resources place on the output of the economy and economic growth. Even so, energy remains important.

Energy is important for growth because production is a function of capital, labor, and energy, not just the former two or just the latter as neoclassical growth models or biophysical production models taken literally would indicate. Both theory and time series results support these claims. Furthermore, the elasticity of substitution between energy and capital is likely to be low and energy is needed to produce the other inputs to production, is available in finite quantities on the Earth’s surface, and is non-recyclable.

However, the estimated output elasticity of energy and natural resources in general should be small in recent decades reflecting the market price determined output share. The current low price of energy reflects a low marginal productivity because of this heavy use. Resources have become increasingly abundant since the Industrial Revolution - evidence suggests that the energy cost share has declined continuously since then alongside the energy intensity of GDP.

Various factors have contributed to declining energy intensities but research is less clear on the relative importance of these variables. Different energy qualities have differing productivities. In particular, modeling the effect of electricity on output is important. Part of the reduction in energy intensities in developed economies may be due to the shift to higher quality fuels. Some research indicates that most of the historical reductions in energy intensity in developed economies and China have been due to technical change but other research finds a much larger role for structural change. Technological change tends to be offset to some degree by the rebound effect. Structural change towards more service-intensive economies tends to have less impact than is commonly thought because service industries in fact need energy intensive infrastructures. In fact energy-saving technical progress in manufacturing industry that reduces the apparent share of manufacturing in the economy may be more important.

As this survey shows, there is clearly much scope for further research to clarify the prospects for decoupling energy use and economic growth and for understanding the role of energy in growth.

Position at Lund University

Lund University are advertising a position in sustainable development and energy. You need to be less than 5 years post-PhD except in attenuating circumstances. You need to be able to teach in English. The emphasis is on the research side. My collaborator Astrid Kander is director of the platform for economic energy research at Lund and you can contact her for more information. I'm planning to visit Lund later this year.

Grattan Institute CPRS Report

The Grattan Institute has a report on the CPRS out today. The CPRS is in hibernation or maybe dead but the report argues as most of us did that the compensation proposed by the government was not economically justified. Here is their blurb:

"Like much of the world, Australia has debated putting a price on carbon emissions (a “carbon price”) with an emissions trading scheme or tax. A carbon price aims to induce structural change in the economy that will reduce emissions and consequently the risks of global warming.

The Australian debate has been dominated by concerns that Australia might lose industry and jobs offshore if it has a carbon price when competitor countries do not. If Australian production moves to countries with higher emissions, this would defeat the purpose of carbon pricing. To avoid this possibility, and protect industry from such an event, government plans to provide some industries with free carbon permits. The report is a detailed industry by industry analysis of the impact of carbon pricing.

We find that much of the protection proposed for the major emissions-intensive industries is unnecessary or poorly targeted. It would delay the structural adjustment required to move to a lower carbon economy.

Using industry data, the report finds that many of the recipient companies will be internationally competitive even if they receive no free permits. Many of the industries that would not be competitive would emit less carbon if they moved offshore, which is the purpose of carbon pricing. The proposed free permits will mute the incentives to reduce carbon emissions. They are also very expensive for other Australian taxpayers."

Shifts in the Composition of Output

This is the penultimate section of the paper that I'll post. Now I'm going on to rewriting the conclusions and then a massive edit. I've got 15,000 words and 179 references!

Shifts in the Composition of Output

Output mix typically changes over the course of economic development. In the earlier phases of development there is a shift away from agriculture towards heavy industry, while in the later stages of development there is a shift from the more resource intensive extractive and heavy industrial sectors towards services and lighter manufacturing. Different industries have different energy intensities. It is often argued that this will result in an increase in energy used per unit of output in the early stages of economic development and a reduction in energy used per unit output in the later stages of economic development (Panayotou, 1993).

However, there is reason to believe that the energy-saving effects of structural changes are overstated. When the indirect energy use embodied in manufactured products and services is taken into account, the US service and household sectors are more energy intensive than they first appear (Costanza, 1980). Service industries still need large energy and resource inputs. The service being sold may be intangible but the office towers, shopping malls, warehouses, rental apartment complexes etc. where the activity is conducted are very tangible and energy is used in their construction, operation and maintenance. Furthermore, consumers use large amounts of energy and resources in commuting to work, shop etc.

The effect of the Internet on the energy intensity of commerce has received increasing attention (Yi and Thomas, 2007). Obviously, individual technologies such as news websites vs. newspapers can greatly reduce emissions (e.g. Toffel and Horvath, 2004) but the effects on other activities could outweigh the gains. Romm et al. (1999) argue that the environmental costs of the greater dispersal of population engendered by telecommuting would not outweigh the reduction in commuting costs suggesting a strong energy-conserving Internet effect. But Matthews et al. (2002) and Williams and Tagami (2008) provide evidence that online book retailing use more energy than traditional retail while Herring and Roy (2002) show that electronic distance learning results in more energy use than traditional distance learning with printed material.

There may also be a tendency for consumers to use more energy directly over time as their consumption of the services appliances, housing, transport etc. increases. Judson et al. (1999) find that the consumer sector sees rising energy intensity over time, ceteris paribus, while the manufacturing sector sees decreasing energy intensity.

Furthermore, on a global scale there may be limits to the extent to which developing countries can replicate the structural shift that has occurred in the developed economies to the extent that this has occurred by outsourcing manufacturing overseas rather than simply from an expansion in service activities. However, the evidence shows that trade does not result in reductions in pollution in developed countries through the off-shoring of pollution intensive industries (Levinson, 2010, Aguayo and Gallagher, 2005; Kander and Lindmark, 2006). Additionally, if the service sector does require substantial material support, it is not clear whether the developed world can continue to shift in the direction of a growing service share of GDP indefinitely. In fact, as manufacturing prices have fallen relative to the prices of services (Baumol’s disease), even the relative decline of manufacturing in developed countries is exaggerated when the relative sizes of the sectors are computed in current prices (Kander, 2005).

Kander (2002) and Stern (2010) find a relatively small role for structural change in reducing energy intensity in Sweden (1800-2000) and the world (1971-2007), respectively. But, using a much finer disaggregation of industries, Sue Wing (2008) finds that structural change explained most of the decline in energy intensity in the United States (1958-2000), especially before 1980.

References
Aguayo, F., and K. P. Gallagher (2005) Economic reform, energy, and development: the case of Mexican manufacturing, Energy Policy 33: 829–837.
Costanza, R. (1980). “Embodied energy and economic valuation.” Science 210: 1219-1224.
Herring, H. and R. Roy (2002). “Sustainable services, electronic education and the rebound effect.” Environmental Impact Assessment Review 22: 525-542.
Judson, R. A., R. Schmalensee, and T. M. Stoker (1999). “Economic development and the structure of demand for commercial energy.” The Energy Journal 20(2): 29-57.
Kander, A. (2002). Economic Growth, Energy Consumption and CO2 Emissions in Sweden 1800-2000, Lund Studies in Economic History No. 19, Lund, Sweden.
Kander, A. (2005). Baumol's disease and dematerialization of the economy, Ecological Economics 55(1): 119-130.
Kander, A. and Lindmark, M. (2006). "Foreign trade and declining pollution in Sweden: a decomposition analysis of long-term structural and technological effects," Energy Policy 34(13): 1590-1599.
Levinson, A. (2010) Offshoring pollution: Is the United States increasingly importing polluting goods? Review of Environmental Economics and Policy 4(1): 63-83.
Matthews, H. S., E. Williams, T. Tagami, and C. T. Hendrickson (2002). “Energy Implications of Online Book Retailing in the United States and Japan.” Environmental Impact Assessment Review 22: 493-507.
Panayotou, T. (1993). Empirical Tests and Policy Analysis of Environmental Degradation at Different Stages of Economic Development. Working Paper WP238, Technology and Employment Programme, International Labour Office, Geneva.
Romm, J., A. Rosenfeld and S. Herrmann (1999). The Internet Economy and Global Warming: A Scenario of the Impact of E-Commerce on Energy and the Environment. The Center for Energy and Climate Solutions, The Global Environment and Technology Foundation, Arlington, VA.
Stern D. I. (2010) Modeling international trends in energy efficiency and carbon emissions, Environmental Economics Research Hub Research Report 54.
Sue Wing, I. (2008) Explaining the declining energy intensity of the U.S. economy, Resource and Energy Economics 30: 21–49.
Toffel, M. W. and A. Horvath (2004) Environmental Implications of Wireless Technologies: News Delivery and Business Meetings, Environ. Sci. Technol. 38(11): 2961–2970.
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Innovation and Energy Efficiency

Changes in the energy/GDP ratio that are not related to changes in the relative price of energy are called changes in the autonomous energy efficiency index (AEEI, Kaufmann, 2004). These could be due to any of the determinants of the relationship between energy and output listed at the beginning of this section and not just technological change. Even A in (3) is just general TFP and, therefore, includes the effects of technological change on augmenting other inputs as well as energy. There are two related ways of measuring the level of technology that control for the other factors that we consider in this section of this paper. The first, distance function, approach asks: “What is the minimum energy requirement to produce a given level of output holding all other inputs constant?” The level of energy efficiency in period t relative to period 0, Bt , is given by:
(4)




where y is the vector of outputs and x the vector of non-energy inputs with subscripts indicating the periods and Ei() is a function indicating the minimum energy required in period i in order to achieve the given outputs given the level of inputs. Equation (4) can also be used to measure the relative level of energy efficiency of two countries. The functions in (4) can be estimated econometrically (e.g. Stern, 2010) or non-parametrically.

An alternative approach is an index of energy augmenting technical change. This involves a reformulation of the production function (3):

(5)



so that each input is multiplied by its own technology factor Ai that converts crude units of the input into “effective units”. AE is the index of energy augmenting technical change, which holds the use of all other inputs and their augmentation indices constant. In some but not all situations, AE = B.

Estimates of the trend in AEEI, energy efficiency, or the energy augmentation index are mixed. This is likely because the direction of change has not been constant and varies across different sectors of the economy and strong correlations between the state of technology and the levels of other inputs result in biased and inconsistent results (Stern, 2010). Jorgensen and Wilcoxen (1993) estimated that autonomous energy efficiency is declining. Berndt et al. (1993) use a model with linear time trends to estimate augmentation trends labor, electricity, fuels, machines, and structures in US manufacturing industry between 1965 and 1987. The rates of augmentation are -1.2%, 11.8%, -3.4%, 4.4%, and 8.7% respectively per annum. Patterns for Canada and France were entirely different. Stern (2010) uses a method intended to address the issue of biased estimation. He finds that energy efficiency (4) improved from 1971 to 2007 in most developed economies, former communist countries including China, and in India. But there was no improvement or a reduction in energy efficiency in many. Globally, such technological change resulted in 40% growth in energy use over the period than would otherwise have been the case.

Judson et al. (1999) estimate separate EKC relations for energy consumption in each of a number of energy-consuming sectors for a large panel of data. They estimate time effects that show rising energy consumption over time in the household and other sector but flat to declining time effects in industry and construction. This suggests that technical innovations tend to introduce more energy using appliances to households and energy saving techniques to industry (Stern, 2002).

When there is endogenous technological change, changes in prices may induce technological changes. As a result, an increase in energy prices does tend to accelerate the development of energy saving technologies, while periods of falling energy prices may result in energy-using technological change. There can also be an effect on the general rate of TFP growth (Berndt, 1990). Jorgenson (1984) found that technical change was biased and tended to be energy using. If this is the case, lower energy prices tend to accelerate TFP growth and vice versa. More recent results may contradict this conclusion (e.g. Judson et al., 1999). Newell et al. (1999) provide some information on the degree to which energy price increases induce improvements in the energy efficiency of consumer products. They decompose the changes in cost and energy efficiency of various energy using appliances using the concept of a transformation frontier of possible cost and efficiency combinations. For room air conditioners, large reductions in cost holding efficiency and cooling capacity occurred from 1960 to 1980 in the US. Also the cost of high efficiency air conditioners relative to inefficient ones was reduced. From 1980 to 1990 the former trend ended but the mix of air conditioners offered from those that were feasible to manufacture shifted sharply in favor of higher efficiency. Only about one quarter of the gain in energy efficiency since 1973 was induced by higher energy prices. Another quarter was found to be due to raised government standards and labeling. For gas water heaters the induced improvements were close to one half of the total, although much less cost reducing technical change occurred. Popp (2002) similarly finds that increased energy prices have a significant though quantitatively small effect on the rate of patenting in the energy sector.

Recent research investigates the factors that affect the adoption of energy efficiency policies or energy efficiency technology (Matisoff, 2008; Fredriksson et al., 2004; Gillingham et al., 2009; Wei et al., 2009; Stern, 2010). Differences across countries and states, over time, and among individuals can be due to differences in endowments and preferences but also due to market failures. Gillingham et al. (2009) provide a classification of various market and behavioral failures that affect energy efficiency. Market failures include environmental externalities, information problems, liquidity constraints in capital markets, and failures of innovation markets. Fredriksson et al. (2004) find that the greater the corruptibility of policy-makers the less stringent is energy policy and that the greater lobby group coordination costs are the more stringent energy policy is.

Matisoff (2008) finds that the most significant variable affecting the adoption of energy efficiency programs across U.S. states is citizen ideology. A broad band of states from Florida to Idaho has not adopted any policies. The initial level of criteria air pollutants was also a significant determinant of the number of programs adopted and the adoption of a renewable portfolio standard. Wei et al. (2009) compute an energy efficiency index based on the data envelopment analysis approach to examine energy efficiency in China. Using 1997–2006 panel data for 29 provinces, they find that energy efficiency is negatively associated with the secondary industry share in GDP, the state-owned economic share in GDP and the government expenditure share in GDP, and is positively associated with the technical level and non-coal share in energy consumption.

Stern (2010) uses a stochastic production frontier to model trends in energy efficiency (4) over time in a panel of 85 countries. He finds that energy efficiency rises with increasing general total factor productivity but is also higher in countries with more undervalued exchange rates in PPP terms. Higher fossil fuel reserves are associated with lower energy efficiency. Energy efficiency converges over time across countries and technological change was the most important factor mitigating the global increase in energy use and carbon emissions due to economic growth.

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