CASE STUDY 3: THE DETERMINANTS OF THE ENERGY/ GDP RELATIONSHIP
One of the most widely cited macroeconomic indicators of sustainability is the ratio of total energy use to total economic activity, or the energy/real GDP ratio (E/GDP ratio). This ratio has declined since 1950 in many industrial nations. There is controversy regarding the interpretation of this decline. Many economists and energy analysts argue that the decline indicates that the relation between energy use and economic activity is relatively weak. This interpretation is disputed by many biophysical economists, who argue that the decline in the E/ GDP ratio overstates the ability to decouple energy use and economic activity because many analyses of the E/GDP ratio ignore the effect of changes in energy quality (Fig. 1).
The effect of changes in energy quality (and changes in energy prices and types of goods and services produced and consumed) on the E/GDP ratio can be estimated using Eq. (7):
electricity is electricity generated from hydro, nuclear, solar, or geothermal sources; PCE is real personal consumption expenditures spent directly on energy by households; product mix measures the fraction of GDP that originates in energy-intensive sectors (e. g., chemicals) or non-energy-intensive sectors (e. g., services); and price is a measure of real energy prices.
The effect of energy quality on the E/GDP ratio is measured by the fraction of total energy consumption from individual fuels. The sign on the regression coefficients b1—Ьз is expected to be negative because natural gas, oil, and primary electricity can do more useful work (and therefore generate more economic output) per heat unit than coal. The rate at which an increase in the use of natural gas, oil, or primary electricity reduces the E/GDP ratio is not constant. Engineering studies indicate that the efficiency with which energies of different types are converted to useful work depends on their use. Petroleum can provide more motive power per heat unit of coal, but this advantage nearly disappears if petroleum is used as a source of heat. From an economic perspective, the law of diminishing returns implies that the first uses of high-quality energies are directed at tasks that are best able to make use of the physical, technical, and economic aspects of an energy type that combine to determine its high-quality status. As the use of a high-quality energy source expands, it is used for tasks that are less able to make use of the attributes that confer high quality. The combination of physical differences in the use of energy and the economic ordering in which they are applied to these tasks implies that the amount of economic activity generated per heat unit diminishes as the use of a high-quality energy expands. Diminishing returns on energy quality is imposed on the model by specifying the fraction of the energy budget from petroleum, primary electricity, natural gas, or oil in natural
logarithms. This specification ensures that the first uses of high-quality energies decrease the energy/ GDP ratio faster than the last uses.
The regression results indicate that Eq. (7) can be used to account for most of the variation in the E/ GDP ratio for France, Germany, Japan, and the United Kingdom during the post-World War II period and in the United States since 1929. All the variables have the sign expected by economic theory and are statistically significant, and the error terms have the properties assumed by the estimation technique.
Analysis of regression results indicate that changes in energy mix can account for a significant portion of the downward trend in E/GDP ratios. The change from coal to petroleum and petroleum to primary electricity is associated with a general decline in the E/GDP ratio in France, Germany, the United Kingdom, and the United States during the post-World War II period (Fig. 4). The fraction of total energy consumption supplied by petroleum increased steadily for each nation through the early 1970s. After the first oil shock, the fraction of total energy use from petroleum remained steady or declined slightly in these four nations. However, energy mix continued to reduce the E/real GDP ratio after the first oil shock because the fraction of total energy use from primary electricity increased steadily. The effect of changes in energy mix on the E/GDP ratio shows no trend over time in Japan, where the fraction of total energy consumption supplied by primary electricity declined through the early 1970s and increased steadily thereafter. This U shape offsets the steady increase in the fraction of total energy use from petroleum that occurred prior to 1973.
These regression results indicate that the historical reduction in the E/GDP ratio is associated with shifts in the types of energies used and the types of goods and services consumed and produced. Diminishing returns to high-quality energies and the continued consumption of goods from energy-intensive sectors such as manufacturing imply that the ability of changes in the composition of inputs and outputs to reduce the E/real GDP ratio further is limited.