Wednesday, October 3, 2018

Energy Intensity, Growth, and Technical Change

I have a new working paper out, coauthored with Akshay Shanker. Akshay recently completed his PhD at the Crawford School and is currently working on the Energy Change Institute's Grand Challenge Project among other things. This paper was one of the chapters in Akshay's thesis. Akshay originally came to see me a few years ago about doing some research assistance work. I said: "The best thing you could do is to write a paper with me – I want to explain why energy intensity has declined using endogenous growth theory." This paper is the result. Along the way, we got additional funding from the College of Asia and the Pacific, the Handelsbanken Foundation, and the Australian Research Council.

World and U.S. energy intensities have declined over the past century, falling at an average rate of approximately 1.2–1.5 percent a year. As Csereklyei et al. (2016) showed, the relationship has been very stable. The decline has persisted through periods of stagnating or even falling energy prices, suggesting the decline is driven in large part by autonomous factors, independent of price changes.

In this paper, we use directed technical change theory to understand the autonomous decline in energy intensity and investigate whether the decline will continue. The results depend on whether the growing stock of knowledge makes R&D easier over time – known as state-dependent innovation – or whether R&D becomes harder over time.

Along a growth path where real energy prices are constant, energy use increases, energy-augmenting technologies – technologies that improve the productivity of energy ceteris paribus – advance, and the price of energy services falls. The fall in the price of energy services reduces profitability and incentives for energy-augmenting research. However, since the use of energy increases, the "market size" of energy services expands, improving the incentives to perform research that advances energy-augmenting technologies. In the scenario with no state dependence, the growing incentives from the expanding market size are enough to sustain energy-augmenting research. Energy intensity continues to decline, albeit at a slower rate than output growth, due to energy-augmenting innovation. There is asymptotic convergence to a growth path where energy intensity falls at a constant rate due to investment in energy-augmenting technologies. Consistent with the data, energy intensity declines more slowly than output grows, implying that energy use continues to increase.

This graph shows two growth paths – for countries that are initially more or less energy intensive – that converge to the balanced growth path G(Y) as their economies grow:

This is very consistent with the empirical evidence presented by Csereklyei et al. (2016).

However, the rate of labor-augmenting research is more rapid along the balanced growth path and there will be a shift from energy-augmenting research to labor-augmenting research for a country that starts out relatively energy intensive. This explains Stern and Kander's (2012) finding that the rate of labor-augmenting technical change increased over time in Sweden as the rate of energy-augmenting technical change declined.

The following graph shows the ratio of the energy-augmenting technology to the labor-augmenting technology over time in the US, assuming that the elasticity of substitution between energy and labor services is 0.5:

Up till about 1960, energy-augmenting technical change was more rapid than labor-augmenting technical change and the ratio rose. After this point labor-augmenting technical change was more rapid, but the rise in energy prices in the 1970s induced another period of more rapid energy-augmenting technical change.

In an economy with extreme state-dependence, energy intensity will eventually stop declining because labor-augmenting innovation crowds out energy-augmenting innovation. Our empirical analysis of energy intensity in 100 countries between 1970 and 2010 suggests a scenario without extreme state dependence where energy intensity continues to decline.