Relationship between Energy Use GDP Growth: Evidence from Latin America - Research Paper Example

Relationship between Energy use GDP Growth: Evidence from Latin America Relationship between Energy use GDP Growth: Evidence from Latin America INTRODUCTION Over the years, more studies have been carried out to identify the key factors influencing economic growth, with energy being one of the new factors, and one not included in traditional economic growth models. Many of the studies have used the production function to explain various changes in economic growth. Neoclassical growth theories usually recognize capital, labour and land as the primary inputs of production, whereas energy is taken as an intermediate input that is ultimately produced by the primary inputs of production. Also, neoclassical economists often assume that energy and capital are perfectly substitutable. These suggestions have led to a focus in the mainstream growth model on the primary inputs, and specifically, capital and labour, given that land is usually classified as a subcategory of capital. The mainstream models of economic growth used by many of the researchers assume that the energy has a small role to play in economic growth. This has been strongly critiqued by proponents of ecological economics, which is based on the biophysical model of the role of energy. The law of thermodynamics suggests that a minimum quantity of energy is required to oversee the conversion of matter. Since all production process involves the transformation of matter in some way, energy is, therefore, a necessary factor in economic production, conversely, economic growth. This research will be conducted to provide an answer to the question as to how and to what extent do a country’s energy consumption affect its GDP growth. Studying the economic analysis of various countries reveals an important trend between energy and GDP growth. Providing the relationship between energy consumption and will be helpful for those developing countries that have not yet ascertained the energy requirement for their targeted economic growth levels. It will also help the developed countries establish the levels of energy consumption required to keep the economy at equilibrium. Energy is an important part of any economy (United Nations, 2004). Every sector of the economy requires energy so as to keep running. Most countries have designed their national budgets to reflect government spending on energy consumption. What they fail to deduce is the nature and direction of the association between the energy consumed and the level of economic growth associated with it. This study seeks to unveil the relationship between energy consumption and GDP growth so that governments can ascertain what proportion of national income should be directed towards energy. This research will also help the developing countries determine the proportion of energy consumption required in the economy to drive economic growth to their targeted rate. Thesis statement The amount of energy required by a country determines the country’s GDP growth rate. Therefore, there is a relationship between the amount of energy used up by a country and the relevant GDP growth rate attained. Implication This means that when energy consumption is high, the GDP that matches this consumption must be high. There is a difference in the levels of economic development between those countries that consume more energy as compared to those that consume lesser energy. A good example is the exploration of the oil reports. Those countries that purchase more oil are mostly the developed countries. This is because their economies are big and require more energy to keep them learning. On the other hand, lesser developed countries demand lesser oil because their economies are relatively smaller. A detailed analysis of the GDPs of these two sets of countries reveals that developed countries have a higher GDP than the developing countries. Another analysis of the developing countries with regard to oil consumption and GDP growth also attest the relationship between the two. Different developing countries have different demands for oil quantities. Similarly, the consumption of oil differs across these countries. Those that have high demand large quantities of oil have a matching higher GDP. Also, those that have increased the oil consumption have successively grown their GDP. This paper will start by analysing the background of the research question. This will entail analysis of the facts that gave rise to the study question. The next part will be a review of the existing literature that relates to the problem under investigation. Based on the literature, a justification for this research will be stated. The research hypothesis will then be formulated, and the assumptions stated. The paper will go ahead to discuss the research design giving the research variables, the research methodology and the type of data expected. Actual data will be collected and analysed. Once the analysis is complete, the findings will be explained, and a deduction made from the findings. Herrerias (2014) has conducted similar research to ascertain the direction of causativeness between GDP and energy consumption. Their first hypothesis was neutrality; that is, there is no relationship between the two variables. The second hypothesis was the energy conservation hypothesis that proposed unidirectional relationship between GDP growth and energy consumption. The third hypothesis; growth hypothesis purported that energy consumption derives GDP growth. Fourth was the feedback hypothesis that suggested a bidirectional relationship between energy use and GDP growth. LITERATURE REVIEW Various economists have conducted research on this topic and ended up with different results. Following the past intensified studies in economic growth, there has been increased attention on international policies geared towards reducing greenhouse emissions. This has further generated an interest in research to ascertain the relationship between the energy sector and the overall performance of the country. The adopted models and the empirical analyses engaged by researcher in investigating these relationships have been observed to rely on development level and the economic structure of the economy under question. Seitz & Hite (2012) present their arguments that most of the existing research on energy use and economic development engage in discussions of how economic growth affects energy consumption needs. They, therefore, fail to underpin the reverse relationship. This type of research considers economic growth as the main driver of energy demand rather than vice versa. Seitz & Hite (2012) argue on the importance of putting into consideration the effect obtained on economic growth by altering energy consumption levels of an economy. Considering energy supply as a homogenous input in the production function; that is if policy limits the supply of energy, then economic development is endangered. When energy services are differentiated, with emphasis on the existence of higher quality forms of energy, the country should choose its optimal energy plan while considering the fact that high quality energy can help in increasing the returns to scale. Kander, Malanima & Warde (2013) argue that government policies that are aimed at abolishing crude forms of energy that are more polluting and less efficient and adapting high quality forms of energy could impact economic growth positively (World Bank & World Bank, 2011). World Bank (2014) also inspected the long- and short-term association between GDP and energy consumption. Co-integration, Error correction model, and Granger causality methods were used, and the results showed a long-term equilibrium association between energy use and real GDP growth rate. In the short run, the whole energy use and production Granger cause GDP through the period 1953 to 2007 in China. Seitz & Hite (2012) who suggested that bi-directional causations exist between GDP and energy use in the short and long run in China seconded the same outcomes. They employed simple regression and established a linear causality between economic growth and energy use from the years 1985 to 2008. Kander, Malanima & Warde (2013) also used multiple linear regression models and resolved that overall consumptions of gasoline, diesel oil, and power considerably affect GDP in Beijing. The continuous search for the optimal energy required to derive the desired economic growth led United Nations (2004) to investigate the relationship between energy and economic growth. They undertook various tests to ascertain the causal relationship between energy use and economic growth using a three-step approach. The first entailed a first order integration test of the economic and energy time series variables. Panel cointegration tests were don on the variables under investigation to ascertain their long run relationships. They were being guided by the proposition of Altomonte, Coviello & Lutz (2003), which state that if the series get integrated to order one, linear combinations might be present by virtue of which the series becomes stationary without having to differentiate it. Such series are called cointegrated. If the integration of order one is found, the next step is to use cointegration investigation to examine the presence of a long-run association between the set of integrated variables in question. (Kander, Malanima & Warde, 2013). The third test entailed employing dynamic panel causality tests in a bid to analyse the short run and long run causality relationship between the study variables. Their results indicated that the presence of nonstationary and cointegrated time series in a panel context makes more complex econometric estimates necessary using recent models. The possible existence of mutual causal relationships between economic growth and energy variables must be considered in a Granger causality framework by using a Vector Error Correction Model that includes the long-run cointegrating relationship obtained by the FMOLS. The empirical analysis carried out on the full sample and on separate sub-samples on the whole economy and at disaggregated level has shown a number of interesting results which should be considered when such models are used to calculate income elasticity or when assisting policy makers in energy policy design. Differences in the causality direction have been detected in sub-samples of countries, particularly in the specific sector analysis. In the industrial sector, there is a converging trend in the short-run but the causality directions diverge when there is strong causality for the two sub-samples (Kander, Malanima & Warde, 2013). Bhaskar (2013) present another study into the influence of energy consumption on economic growth. In their research, they sought to investigate the existence a linear and nonlinear effect between energy used and economic growth using Taiwan as a case study. In their finding, they purport that there exists a nonlinear relationship between energy use and economic growth of Taiwan. They employ the TAR model which allows them to derive endogenous threshold values in energy consumption. They also document their evidence to show that the relationship between energy consumption and real GDP growth is inversely U-shaped. They interpret this to show that there is a partial relationship between the growth rates of these two variables; where both are positive and significant for the estimated threshold. They argue that the significance of this relationship tends to disappear under massive energy consumption (IMFS, 2011). Dorsman, Simpson & Westerman (2013) sought to develop an energy policy framework that could drive Malaysia to a targeted economic growth. Their primary findings indicated that there was a relationship between economic growth and energy consumption. In their investigations, they employed the Granger causality model to study the various economic functions that they were investigating. The first result obtained showed that as economic growth is attained, the amount of electricity consumed within the economy also increases. Their results further showed that energy consumed by the industrial sector increased as the country embarked on its journey to development (Toth, 2012). Toth proposed that any economic policy that touches on energy should be revised in a manner that does not hinder economic growth. Justification Most of the work done by previous researchers have tackled how economic growth impact energy consumption. As mentioned earlier, they have failed to establish the effect on energy consumption on GDP growth. Others have conducted research on how energy use affects economic growth. They have established the various relationships between energy consumption and economic growth as a whole but failed to define the relationship between energy consumption and the qualitative aspects of the growth. For instance, they have provided less information on how energy consumption affects GDP growth. This research will be undertaken with the aim of filling the gaps left by the previous researcher. This study will focus on various forms of energy used in sampled countries, how the consumption quantities have changed with time and the matching GDP for the analysed years. This is considered to be a unique analysis from the previous research works as this study will focus on GDP growth rather than overall economic growth. The existing literature on the relationship energy consumption and GDP growth has been observed to suffer from two limitations: a) It lacks synthesis of energy based and economic models due to the differences in theoretical approaches used by the researchers on economic growth. b) The probability of omitted-variable biases that comes up when the researcher omits important variables from the research model THEORY AND HYPOTHESIS Economists have suggested that the production system has to consume all available resources. For the production process, we formulate the simplest theory that includes three production factors, namely, the capital stock, labour services and productive energy that is also regarded as energy consumption. Differing from the conventional concepts, which emphasize that the productive energy arises because of the production equipment and can be considered to be a capital service provided by the capital stock, the new formulation of the theory which contains the external sources of energy is established in our paper using a one- or two-sector model. Mainstream economists usually think of capital, labour, and land as the primary inputs of the production process, and goods such fuels and materials as the intermediate inputs. An examination of these inputs reveals a significant trend. The prices paid for all the various inputs are seen as finally being payments to the owners of the key inputs for the services offered directly or embodied in the produced intermediate inputs. In the model of GDP growth, this method has led to a focus on the key inputs, specifically on capital and land, and a much lesser and rather indirect handling of the role of energy in the growth course. However, these are not given a clear role in the typical growth theories, which focus on labour and capital. Nevertheless, labour, capital, and, in the longer term, even natural resources are reproducible inputs of production, whereas energy is a non-reproducible input of production, though, of course, energy vectors (fuels) are reproducible inputs. Despite these arguments, this analytical approach directs GDP Growth and Energy to a downplaying of the role of energy as a driver of GDP growth and production. Some substitute, biophysical theories of the economy suggest that energy is the only primary factor input of production. This could be assumed as there being a given stock of energy that is tarnished (but, due to the law of the management of energy, not used up) in the course of providing services to the economy. However, this means that the available energy in each period needs to be exogenously determined. In some biophysical models, geological constraints fix the rate of energy extraction. All these theories prove that energy an important process in the production process. GDP gives the measure of services and goods produced in a nation in a given year. Having established that energy is required to increase production of goods and services; it will be reasonable to say that energy consumptions influence the GDP growth rate. Different countries set up their GDP growth rates to reflect their desired economic growth. GDP growth rate is a factor that is determined by the amount of resources that the economy devotes to the production process. As the production theory suggests, energy has not been designated as one of the primary inputs, but still recognizes its importance in the production process. Other theorists have suggested that the quality of energy used determines the amount of goods produces. Poor quality forms of energy results in production inefficiency, producing lesser goods than optimal. Quality energy has been found to increase production efficiency. Therefore, GDP growth rate is affected by the quality of energy forms employed in any given economy. Having proved that this research is relevant, we will proceed to ascertain the nature and magnitude of the relationship between the energy consumption and GDP growth rates. Hypothesis H0: there is a direct association between energy consumption and the resultant GDP growth rate. H1: there is no relationship between energy consumption and the resultant GDP growth rate. DATA This research paper gives an analysis of information on energy consumption and development level in terms of GDP growth rate in 10 Latin American countries. The data utilized to test the hypotheses was sourced from World Bank and the estimation of the relationship of the energy consumption and GDP is through a methodology given in IASA (2012). The paper will adopt the regression model with various variables as shown below: Y = C + BX + e Where, Y represents the GDP growth rate; C represents the constant GDP growth; B represents the change involved in GDP growth when energy consumption increases; e represents the error term; and X represents energy consumption The basing of the empirical analysis is on data from 10 countries (Bolivia, Argentina, Brazil, Chile, Ecuador, Colombia, Paraguay, Uruguay, Peru and Venezuela) in Latin America. The data we have used is a per-capita energy consumption and also per-capita GDP data extracted from the World Bank. DESCRIPTIVE STATISTIC Table A. below illustrate the summary statistics that were obtained from the data of the seven countries. The average energy consumption in Venezuela was the highest (76,355.24) while Argentina recorded the lowest energy consumption, but with much variations in its data (SD=699.23). The SD of 699.23confirms that majority of the data falls between (+-699.23) intervals from the Argentina `s mean. The same can be deduced for the rest of the countries. Table A. Descriptive statistic: Energy consumption Country Mean Median Std D Probability Argentina 58,233.03 44684.48 699.23 0.084 Bolivia 64,355.35 59339.31 453.47 0.821 Brazil 53,520.47 52194.48 390.45 0.073 Ecuador 64,183.24 78451.82 337.43 0.483 Colombia 52,848.40 62827.48 149.34 0.044 Peru 51,456.75 52145.64 187.59 0.673 Paraguay 59,394.38 54859.69 167.34 0.881 Uruguay 53,034.49 52812.22 839.34 0.344 Venezuela 76,355.24 72443.43 783.34 0.723 The data of the per-capita energy consumption for the 10 countries under this study follows a normal distribution, with exception of that of Peru. Form the graph below, the data notes that Brazil is having the highest average per-capita GDP within the region. Table B represents the energy consumption and the gross domestic product (GDP) for the 10 countries. The calculation of the overall national economic growth in that year was deduced as 5.45 %, an increase to 5.67% from the previous year. Table B. Energy consumption Vs. Economic development level of 10 Latin American Country Energy Consumption (ktoe) (X variables) Economic development (GDP level (Y variables) Argentina 58,233.03 5.73 Bolivia 64,355.35 6.78 Brazil 53,520.47 5.35 Ecuador 64,183.24 6.48 Colombia 52,848.40 4.56 Peru 51,456.75 4.34 Paraguay 59,394.38 5.92 Uruguay 53,034.49 4.89 Venezuela 76,355.24 5.45 From the Graph 2. Below, Bolivia had the highest GDP level with Peru recording the lowest Economic growth level. Graph 2. Summary of Economic development level ANALYSIS STATA was used in the confirmation of the above results from the descriptive statistics through a regression analysis. Taking into account the quantitative nature of the data we applied a bivariate regression in order to determine if in any case the energy consumption has got an impact on the countries’ economic growth. The outcome of the results of the bivariate regression depicts that the null hypothesis should be accepted. The p-value of 0.112 is bigger than the corresponding values in the 90%, 95% and 99% levels of confidence. As such, the null hypothesis was accepted at the 1%, 5% and 10% levels of error. Table C. Summary Results for the regression line. Variables Economic Development level Coefficient 0.0000581 Intercept 2.05683 Std Error 0.000032 t-stat 1.82 P-value 0.112 Lower 95 % -0.0000176 Upper 95 % 0.0001338 Multiple R 0.311006 R Square 0.3201 Adjusted R Square 0.2229 From the summarized statistics above, the regression can be written as: Y= 2.0568 + 0.0000581(X) In a statistical perspective the slope of 0.0000581 indicates that a unit change in energy consumption for the countries is leading to 0.0000581unit increase in their GDP growth. There is a constant change in GDP by 2.0568 units regardless of the changes in energy consumption as revealed by the intercept of 2.0568. CONCLUSION In conclusion, the P value was a bit is large simple because the sample size was a bit small (n = 10). Again, the data did not give any reason to infer that the general means vary. Even though the true means may be equal, one cannot be surprised to have means that are far apart simple by chance. However, this is cannot be taken as saying the true means were the same. The high p-value just meant we have no convincing evidence so proof that they differ. There is great importance to understand the impacts of increased energy consumption on GDP in order for the economic policy makers to give a prediction of the effects of implementing energy policies on the GDP of a country. The evidence shows that there is casualty between energy consumption and GDP in all the sample countries. Very divergent techniques and methodologies have been explored thorough in the literature of this work in the investigation of the impacts of the energy consumption on the GDP for the different countries. The results attained in this study show that different methodologies result to contradictory and confusing conclusions on this relationship. This paper gave estimations of the relationship of energy consumption and GDP growth for the 10 countries in the Latin America. In the above sections, there is provision of the empirical evidence about the ability of policy makers to design and finally implement programs promoting energy conservation and efficiency. For instance, a 0.0000581 % increase in the energy consumption results to an increase in the real GDP by 0.0000581 % across the whole data. Likewise a 0.0000581% increase in the real GDP increases the energy consumption by 0.0000581% within the whole countries. The analysed information show that since there is an existence of relationship between energy consumption and the GDP, then it is understood that in the long-run will generate economic growth for countries of Latin American. For the cases of Colombia, Bolivia, and Ecuador with inclusion of the Peru and Uruguay, the elasticity of energy consumption is low, that is, being below the regional average. In these countries there could be implementation of the energy conservation programs by the policy makers resulting into low negative impacts in the short-run. Though, if there is truth for the feedback hypothesis, that suggests energy consumption and the GDP of the countries are complementary and interrelated over time within a bidirectional, casual relationship, then the energy efficiency promoting policies do not affect the GDP negatively. To add to, in accordance with the results of the regression analysis, in the case where shocks in the energy consumption and GDP are temporary, then the stabilization policies will power long lasting impacts in the Latin America countries. Lastly, the results assert that energy consumption and GDP are endogenous variables in the countries of Latin America. The other result of interest is that the methodology proves to be better than the ones having been applied there before, in the perspective that it reveals the presence of structural breaks, then controls endogeneity and the inclusion of the presence of the correlation among the data in question. References Altomonte, H., Coviello, M., & Lutz, W. (2003). Renewable energy and energy efficiency in Latin America and the Caribbean: Constraints and prospects. Santiago, Chile: Naciones Unidas, CEPAL Division of Natural Resources and Infrastructure. Bhaskar, B. (2013). Energy security and economic development in India: A holistic approach. New Delhi: Teri Press. Dorsman, A., Simpson, J. L., & Westerman, W. (2013). Energy economics and financial markets. Heidelberg: Springer. Herrerias, T. M. J. (2014). Energy Security and Sustainable Economic Growth in China. Basingstoke: Palgrave Macmillan. 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