Determinants of Renewable Energy Consumption – The Role of Democratic Institutions

Recent devastating floods in Germany and China’s Henan province increase public concerns over climate change. As a result, renewable energy is getting more attention as an essential source to mitigate global warming. However, policymakers must understand the determinants of renewable energy consumption to incentivize the market to expand renewable energy capacity effectively. Among others, the mainstream literature recognizes GDP per capita, real oil price, CO2 emission, and trade openness as the main factors driving renewable energy consumption.

Existing literature mainly supports a positive effect of real oil price and CO2 emission on renewable energy consumption. Yet, there is no consensus on GDP per capita and trade openness. To be specific, the effect of the production growth can be ambiguous. One strand of the literature finds a positive association between GDP per capita growth and renewable energy consumption growth. A positive “income effect” supports their arguments. That is, as households are getting richer and the economy is getting stronger, the society is warier of the environmental issue and able to pay “environmental premium”, which is measured by the gap between the unit cost of the renewable energy and the non-renewable energy. This increased relative consumption accelerates both the deployment of and the R&D investment in renewable energy and lowers the cost of it, thus motivating people to consume further. On the other hand, another stream of the literature highlights the negative “substitution effect” by emphasizing the point that as the economic growth increases, the energy capacity must be passively raised to match the surging demand. Suppose the renewable energy price is way higher or the construction period is relatively much longer than that of the non-renewable energy. The demand side pushes the market to opt for fossil fuels and further reduce the use of renewable energy. As for the trade openness, it is usually assumed to be an excellent measure of access to foreign renewable energy technologies. Therefore, the earlier literature reaches the consensus that trade openness promotes renewable energy consumption. However, the recent “pollution haven” hypothesis suggests that trade openness could also deteriorate renewable energy consumption because trade openness may be boosted by foreign direct investment (FDI) attracted by less strict environmental policies. Trade openness negatively impacts renewable energy consumption.

From the above discussion we may realize that the contradicting results, typically from the GDP per capita and the trade openness, could originate from the divergent public attention toward the environmental protection and the environmental policies introduced by the government. On top of that, both public attitude and environmental policy are directly associated with democratic quality. As a result, we may potentially explain the different effects of the determinants on renewable energy consumption through the indirect channel of the democratic institutional level. Chen et al. (2021) (hereinafter CMT) highlights this critical role. By using panel data for 97 countries covering the period between 1995 and 2015 and employing a panel threshold regression model, they find the higher economic growth fosters the use of renewable energy consumption only if the rights of people, measured by a democracy score, Polity IV, are preserved above a certain level. This is the case where the positive “income effect” is more significant than the negative “substitution effect”. In contrast, CMT observes a negative relationship between the economic growth and renewable energy consumption for less democratic countries and implicates that the negative “substitution effect” is more substantial in those countries. Their findings are consistent with the fact that democratic countries allocate more resources to cleaner production when public attention on environmental protection rises. Meanwhile, the less democratic countries have less concern over environmental issues and carry out less restrictive environmental policies. This is due to, normally, the authority of less democratic countries concentrates more on growth efficiency than growth quality, and the ordinary people have less power to overturn the procedure and determine the distribution scheme. CMT also finds that trade openness is negatively associated with renewable energy consumption in less democratic countries, but the effect vanishes in highly democratic regimes. One plausible explanation for this could be the “pollution heaven” hypothesis, as we discussed before. In line with the previous findings, CMT confirms a positive relationship between trade openness and renewable energy consumption in developed countries (a high democratic score club).

As we welcome the new age of renewable energy, we usually focus more on reforming the economic structure but, intentionally or unintentionally, ignore the political institution. CMT’s paper sheds some light on the crucial role of democratic institutions in promoting renewable energy consumption and may inspire us.

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. (2021). Determinants of renewable energy consumption: Importance of democratic institutions. Renewable Energy,179, 75-83.


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