Friday, September 4, 2009

Progress on "Hub" Project

My research project funded by the Environmental Economics Research Hub is about the international diffusion of energy efficiency technology at the macro-economic level.

The project has two main stages. In the first stage I estimate a function that explains energy intensity (=the amount of energy used in the economy/GDP) in terms of the level of inputs like capital, labor, and the various types of energy, the structure of the economy, and the state of technology. This part is very similar to my previous work on this topic published in Ecological Economics, Journal of Environment and Development, and Policy Studies Journal. Energy intensity is not a direct measure of energy efficiency technology because of the factors mentioned above. This approach controls for the confounding factors and produces a purer measure of technology. I have decided to adopt the "between estimator" to estimate this model after testing it on the environmental Kuznets curve model (that paper is now available as a Hub Research Report).

In the second stage of the project I am developing a dynamic growth model that should explain why technology varies across countries. I can now feed in data on energy efficiency and investment and the model tells me what the energy efficiency of current investment is (rather than of the installed capacity) and what the price of those current investment goods is:

Z is the energy efficiency of the installed capacity and z that of the new investment. The lower the number the less energy used and, therefore, the more efficient the capital goods are. The model produced z (and B) when I fed in Z. The price of capital goods is assumed to be q=B/z. The more efficient the capital goods the higher their price. This formulation has similar cost implications to the carbon emissions reduction function in Nordhaus' DICE model. I want to eventually get estimates of how the parameter B varies across countries. I am assuming that differences will largely reflect inefficiencies - similar to what Parente and Prescott call "Barriers to Riches". In their model barriers to trade and investment result in GDP being lower than it otherwise would be in poor countries. In my model, inefficiencies result in countries being more dirty than they would otherwise be.

I also computed the "shadow prices" of capital and energy efficiency that would mean that the choice of z was optimal contingent on B:

Lambda is the shadow price of the capital stock and mu that of energy efficiency. Yes, these results surprised me, and there may still be mistakes in the model. But then I realised: "Of course, the shadow price of energy efficiency is negative! The lower Z is the more efficient the economy is!" Increasing Z means reducing energy efficiency. That is bad, so its shadow price is negative.

This is a good check on the internal consistency of my model.

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