Thursday, September 26, 2013

Economic Growth and the Transition from Traditional to Modern Energy in Sweden

During my recent visit to Sweden, we successfully revised and resubmitted a paper, titled: "Economic Growth and the Transition from Traditional to Modern Energy in Sweden". We have now made it available as a working paper in the CAMA Working Paper series.

This paper follows up on the paper we published last year in the Energy Journal. That paper looked at the paradox of energy and growth. How could energy have been important in the Industrial Revolution yet be a fairly small portion of production costs today. The new paper looks at the relative contributions of changes in the quantity, quality, and related technology (so called factor augmenting technical change) of traditional (biomass, animal power) and modern (fossil fuels and hydro-electricity) to economic growth in Sweden between 1850 and 1950. This was the period of the energy transition to modern energy in Sweden.

The graph shows that in 1850 less than 5% of energy in Sweden was derived from modern energy sources. By 1950 around 80% was. There are two large spikes in the share of traditional energy associated with the World Wars when imports of fossil fuels were restricted. The share of biomass in Sweden today is higher than it was in 1950. Because the share of modern energy was so small in the early years, even though the rate of improvement in the efficiency with which it was used was in fact higher than that of traditional energy, it contributed less to growth than traditional energy did. Over time, as the share of modern energy increased, this changed so that modern energy innovation and the increase in the use of (quality adjusted) modern energy contributed more to growth. However, according to our data and model, innovation in energy came to a halt towards the end of this period. By contrast, the role of labor augmenting technical change, which includes both better management of labor, increased human capital per worker etc. accelerated smoothly over time to become the most important driver of growth. Of course, Stern and Kander (2012) found this too. It's nice that the results in the two papers match! :)

The table presents the detailed growth accounting results. We actually computed these contributions for every year and then the table provides averages for each 20-year period. Betwen 1870 and 1910 growth was at first slower and then faster than our simple model fitted to the data predicts. But we found that giving the model more degrees of freedom to fit the wiggles in the data could lead to nonsensical results. It's also possible that it is the data that is mismeasured.

What the data implies is that it took a long time for the innovation in using modern energy to diffuse through the economy as the quantity of modern energy used increased. The following graph shows the rate of (factor-augmenting) technological change associated with each of the three inputs (the model also has capital but we assume its rate is zero):

We probably shouldn't take the negative values too seriously, but as noted above, fitting a more complex model was challenging. There was very rapid innovation in the use of modern energy in 1850-1890 starting at about a 7% per year increase in productivity and falling to about 3% a year. But the contribution to growth in the table started at 0.03% per year and rose to 0.08% per year over this time. Growth accounting type exercises, by attributing all the effects of an innovation to the year it happens, are extremely conservative. In later years, when the quantity of modern energy was much larger, that energy contributed more to growth than it would otherwise have done because those earlier innovations had permanently increased the marginal product of modern energy (ceteris paribus of course...).

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