The Renewable Energy Consumption and Economic Growth Nexus – A New View

In recent years, there is growing attention to renewable energy consumption (hereinafter REC) due to the greater negative association with climate change, larger volatility of fossil energy prices, and more policy-oriented supports toward renewable energy use. To give you some basic insights, tho following figure provides the aggregate REC used by different samples of countries and the next one shows REC as a percentage of total energy consumption.

Source: Chen et al., 2020.

Whereas all groups show monotonic increase at the aggregate level, surprisingly, the two figures seem to describe a different picture for non-OECD and developing countries – although the total REC has increased, the share of REC has declined over time while the opposite is true for OECD and developed countries.  This poses an interesting but substantial question: does REC cause economic growth, and how this potential effect connects to the country’s heterogeneity. Thus, many scholars have extensively examined the nexus between REC and economic growth and tried to disentangle the channels.

Unfortunately, it seems there is no agreement in the literature since researchers find various empirical evidence to support the following hypothesis:

  1. No causal relationship (neutrality hypothesis);
  2. A positive effect of REC on economic growth.

It is quite meaningful to figure out why the existing literature contradict each other and connect them in a unified way. Recent research by Chen, Pinar, and Stengos (2020) (hereinafter CPT) provides a convincing argument to shed some light on this puzzle. 

By reviewing existing studies, CPT realizes past research usually assumes a linear relationship between REC and economic growth. As a result, a contradicting conclusion may be drawn when employing datasets from different sources covering different countries and across different periods.  Moreover, considering that renewable energy storage capacity is lower than that of fossil energy, renewable energy’s initial cost is usually higher than the initial cost of non-renewable energy. In contrast, the marginal cost for renewable energy can diminish at a higher rate than for non-renewable counterparts as the technological improvement is faster in the renewable industry due to larger-scale R&D investment.  Based on these observations, CPT expects that a country with relatively lower REC may not significantly benefit economic growth. However, once the REC level surpasses a certain (unknown) level, the impact on growth may turn out to be significant. In other words, the effect of renewable energy on growth should be nonlinear and depending upon the current REC level. Their conjecture could well explain and generalize the mixed results in the existing literature, and any contradiction may be attributed to the heterogeneity at the countries’ REC level.

To test their argument, CPT employs a panel threshold model specification as the model can detect the turning point and endogenously capture the potential regime-specific nonlinearity. Using a balanced panel data covering 103 countries from 1990 to 2015, they find that 13437-kilowatt hour per capita is the magic number. The insignificant effect of the REC on economic growth becomes significantly positive once a country bypasses that level.

They also find that the turning point can be even lower for non-OECD countries, which underscores more contribution from investing and developing renewable energy in low-income countries since they benefit more from the decreasing costs of REC. As a robustness check, CPT also applies the same technique to test developing countries and finds a similar pattern. As such, they conclude that the linear model can only partially identify the relationship between the REC and economic growth as hypotheses (1) and (2) can both be true. The current level of REC, together with the country’s level heterogeneity, determines the current path of the effect.

Do not worry if it hurts now. Sooner or later, all countries can enjoy economic benefits from renewable energy development.

Chaoyi Chen

Chaoyi CHEN joined the MNB and the MNB Institute in 2020. He received a PhD in Economics from University of Guelph in 2019. His research interests are econometrics and applied econometrics. His research topics have included the threshold regressions,  long-horizon regressions, nonstationary time series regressions, and applications on macroeconomics.


References:

Chen, C., Pinar, M., & Stengos, T. (2020). Renewable energy consumption and economic growth nexus: Evidence from a threshold model. Energy Policy, 139, 111295.


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