An old saying in England is that you wait ages for a bus to come along, and then three arrive all at once. With my long-standing interest in the broad economics of decarbonisation (and how it informs political narratives), that’s how it felt last week: a journal paper (after c. 6 years), input to the World Development Report (a year), topped off with a letter in the FT. All published in the same week as a blitz of activity from the new UK government.
#1: Energy Cost Constancy
First, after an overlong journey by any standard, work between UCL and the Centre for Energy Efficiency (CENEF) in Russia has culminated in a paper “Minus 1” and energy costs constancy: Empirical evidence, theory and policy implications. Led by energy data guru Igor Bashmakov and drawing on varied contributions at UCL, this presents exhaustive evidence that given time, industrialised countries at least have maintained the share of final energy costs (ie. total consumer energy expenditure relative to GDP) within a relatively narrow range, despite large differences in energy prices across countries and over time.
Why does this matter? It suggests that energy systems are, in the long run, highly adaptable. No-one who follows work on induced innovation should be surprised that periods of very high energy prices have prompted substantial innovation, investment and structural change, to reduce dependence on high-cost energy. Conversely though, very cheap energy induces extraordinary degrees of energy wastage – witness the former Soviet countries – leaving those countries ultimately far more exposed to price shocks. There are also of course corresponding reactions on the supply side. For economists, the “minus 1” refers to implication of a “very long run, integrated price elasticity” of minus 1. Thus, 20% higher energy prices over time induce 20% lower energy intensity, hence overall same final energy costs.
Put more succinctly with example: Japan and several west European countries have had end-use energy prices averaging almost twice as high as the US, but use energy twice as efficiently in their economic output – so lowever overall national bill. Notably, high gasoline taxes helped reduce oil dependence. And countries which subsidise energy, expecting that to improve their economies, turned out worse – as large subsidies fostered inefficient use.
Such ‘energy cost constancy’ in itself is not a new suggestion, indeed Bashmakov already posited it in 2007. The new study delves into far more depth, across a range of data sources, countries and indicators, and adds several new points.
First, the timescale of adjustment has been long – on the order of quarter of a century (which as we discuss, is one reason why most energy economists don’t recognise “minus 1” – robust data streams of such duration are hard to come by, and many economic studies refer to “long run” elasticity meaning just a few years). Obviously, that poses both analytic and political challenges.
Second, we also offer an estimate of the impact of trade effects – the much-discussed “outsourcing”. That does have an impact, but mostly seems to indicate an even tighter range of “cost constancy” when measured on basis of the consumption-footprint.
Third, we draw attention to a simple, neat but mostly ignored observation from my colleague Bob Lowe: a proof that the implied energy price elasticity of multi-stage energy systems would necessarily converge to “minus 1”, if there are enough stages. The reason is intuitively simple: any stage that is very unresponsive to price will pass on costs to the next stage, whilst stages which are price sensitive will reduce their energy consumption, thus reducing the extent of cost pass-through. To the extent that modern economies are to an important degree multi-stage energy systems, cumulatively, it all makes physical sense.
Finally, we note that the findings are totally consistent with the Three Domains framing of energy system economics, with its most precise articulation published last year in the Oxford Review of Economic Policy. Low energy prices induce widespread satisficing behaviour – expressed as inattention and wastage, building up over time to needless degrees of energy dependence. Very high prices induce the opposite, as we saw massively in the aftermath of the 1970s oil crises, and yet again in the most recent energy crisis: intense attention, investment and innovation that serves to reduce energy consumption, enhance efficiency, shift to enhance alternate energy technologies, and develop new supply sources. Distinct from day-to-day normal market price fluctuations, the wider economy and political system is engaged as the dynamics of the third, “Transformation Domain”, kicks in.
There is of course a major ‘fly in the ointment’, for both economists and policymakers.
For economists, the implication is actually not that the price elasticity is really ‘minus 1’. It is that price responses are highly non-linear: ‘minus 1’ is simply the average of responses ranging from almost total indifference when energy prices are low, through moderate elasticities during times of moderate prices, and transformative changes from the multiple reactions to price shocks, embodied in innovation and infrastructure that can take many years to work through the system.
For policymakers the implications are even more subtle. It confirms that price is important, but it is not the only lever, nor is it remotely practical for policymakers to impose prices at levels that would constitute a systemic shock to drive the changes sought. The transformations required for deep decarbonisation still pose a policy challenge to design, and sell, a mix of policies that can deliver adequate responses – equivalent to acknowledgement, that if the world actually recognised the real cost of climate change, it would indeed amount to a massive economic shock (and sadly, will if mitigation is not rapidly accelerated). Thus the need to target policies more intelligently, to secure as far as possible “the gain without the pain” of an energy price shock across the entire economy – so as to head off (as much as is still possible) the gatherings shocks of climate impacts.
Which takes me to the other ‘London Buses’, which I’ll add as separate posts to my (long-neglected) website over the next few days.