Economic Growth and Energy Consumption

1









Hoang Pham
Colorado State University
Individual Project
Economic Growth and Energy Consumption
ECON 335
Dr. Anita Pena
May 1
st
, 2014






Honor Pledge: I did not give, receive, or use any unauthorized assistance on this project.
Signed _______________________________
Economic Growth and Energy Consumption

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1. Introduction and Statement of Research Question
Energy is necessary in every production activity. As a result, many people can possibly
believe that energy plays some role in affecting economic growth of a country and inversely,
economic growth is a driving force of energy consumption. For instance, in a country where
energy source is scarce and the price of energy is high, the production cost could be higher in
comparison with other countries, which may limit the exports of that specific country and in turn
restrain economic growth. On the other hand, a country with abundant energy sources and cheap
energy price can usually take huge steps in economic development. The industrial revolutions in
history have proved this point.
In a book namely Confessions of an Economic Hit Man by John Perkins, the author
narrates a story about his own life being an Economic Hit Man (EHM). One of the most critical
jobs of an EHM is to help US government to build a global empire by making smaller countries
economically dependent on Washington. These EHMs, at first, provide favors in the form of
loans to support poorer countries building their own infrastructure such as highways, airports and
electric plants. Then if EHMs are successful, the loans become so big that the debtors have to
default after a few years. According to Perkins, Washington can use this as a condition to take
control over United Nations votes, the installation of military bases or access to precious
resources such as oil or Panama Canal.
In his confession, in 1971, one of Perkins tasks was to overly forecast the electricity
consumption on Java an island of the Republic of Indonesia. His duty was to make people
believed that Javas local economy would boom in the future and hence would demand much
more electricity a good reason for local government to borrow money from US to build more
electrical plants.
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As I read through the book until here, I asked myself how a boom in local economy could
help to predict the energy consumption in that region. If Perkins could do that, why shouldnt I?
And hence, in this paper, I decide to examine the relationship between economic growth and
energy consumption. The research question, therefore, is how economic growth rate helps to
predict energy consumption in a certain country.
2. Formulation of Model
Even though, it is reasonable to believe that economic growth is equivalent to more
economic activities and hence, leads to higher energy consumption, there should be a lot of
problems with my research question (also Perkins job), which is a reason why I choose to test
this relationship. On one hand, economic growth is just one factor that has some correlation with
energy consumption and does not comprehensively explain it. Indeed, energy consumption is
strongly affected by other factors such as population, technology, trade, structure of economy,
development stage of the economy, weather conditions and political events (BP Energy Outlook
report, 2035). On the other hand, as these other factors all have strong correlation with economic
growth rate, omitting these variables in relationship testing would lead to omitted variables bias.
Therefore, in testing the prediction relationship between economic growth and energy
consumption, I estimate the following regression equation using Ordinary Least Square method:
G
E
=
0
+
1
G
Y
+
2
G
P
+
3
T +
4
G
Y
Y + u (*)
G
E
: Energy use growth rate (%)
G
Y
: GDP growth rate (%)
G
P
: Population growth rate (%)
T: Research and Development expenditure (% of GDP)
Y: GDP per capita (USD)
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u: Error term (%)
(*) Regression equation testing the impact of economic growth rate, population growth rate,
research and development expenditure and GDP per capita on energy consumption
In this equation, I also includes population growth rate (G
P
) as a variable because higher
population not only implies more direct usage of energy but also leads to higher demand for
food and other products, which indirectly increase the demand for energy.
Research and Development expenditure (T) represents the level of technology spending of a
certain country. This variable has a strong implication on energy consumption because it can
affect efficiency of energy usage of that country, which in turn influences the demand for energy.
In the equation, the interaction term G
Y
Y indicates that the effect of economic growth on
energy consumption in a certain country is contingent upon the current level of GDP per capita
in that country (stage of development). This interaction term is important due to the fact that in
developed countries, the economic growth does not necessarily affect future energy demand. For
example, developed countries such as United States, United Kingdom, and Switzerland derive
most of their economic growth in service sectors which do not consume much of the physical
energy (The World Fact Book, 2013).
3. Data description
My research uses data of 252 countries that is available on World Banks website. I choose to
examine the data in the year of 2011 due to the largest number of observations reported in that
year. The number of observations, however, changes according to data available in each
specification. The summary of the data is provided in the table 3.1 below:


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Table 3.1 Summary of data
Median Max Min Mean Standard
Deviations
Number of
observations
Energy use growth
rate (%)
1.5984 33.289 -38.260 1.6904 6.2475 165
GDP growth rate
(%)
3.9149 21.816 -10.480 4.1192 3.6678 218
Population growth
rate (%)
1.2461 8.8124 -2.6287 1.3540 1.3069 244
Research and
development
expenditure (% of
GDP)
0.84281 4.3904 0.013350 1.2431 1.0511 70
GDP per capita
(USD)
5,798.6 163,026 245.58 14,675 181.14 220
Year 2011

The figure 3.2 below shows the X-Y scatter plots of Energy use growth rate and the GDP
growth rate among countries. In the graph, Haiti the nation with the highest point is an outlier
with energy growth rate of about 33% and the GDP growth rate of about 5.6%. Some advanced
countries such as Germany, United Kingdoms and United States have negative energy use
growth rate but still have their GDP grow at a positive rate. In general, the scatter plots indicate
an upward relationship between energy consumption and economic growth.
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Figure 3.1 Scatter plots of energy use growth rate and GDP growth rate in 2011
4. Empirical Results
In testing the regression equation (*), I have established 4 specifications of which the results
are shown in the table 4.1 below, using OLS estimations. In these specifications, the error term is
assumed heteroskedastic.
Table 4.1 Regression results
Dependent variables Energy use growth rate (G
E
)
Explanatory variables (1) (2) (3) (4)
GDP growth rate (G
Y
) 0.61***
(0.13)
0.55***
(0.14)
0.43**
(0.77)
0.56**
(0.22)
Population growth rate (G
P
) 0.53*
(0.28)
0.47
(0.36)
0.95**
(0.38)
Research and development
expenditure (T)
-1.68***
(0.51)
-0.88
(0.55)
Interaction term (G
Y
Y) -2.61e-05
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***
(8.88e-06)
Intercept -0.53
(0.72)
-0.97
(0.71)
0.84
(1.40)
0.24
(1.40)
Summary statistics and joint tests
F-statistics 22.59 19.55 12.8 11.97
SER 4.99 4.98 3.99 3.81

0.16 0.17 0.33 0.40

0.15 0.16 0.30 0.36

n 161 160 63 63

Throughout the four models, one can observe that GDP growth rate genuinely has positive
impact on energy use growth rate. The coefficient of G
Y
variable is positive and significant at
1%, 1%, 5% and 5% level respectively to the models. The significance level decreases as more
variables are involved indicating that there is a strong omitted variable bias in the equation; if I
add more variables into the equation, the significance level may continue to decrease. However,
this result generally implies that Perkins job was feasible. By using GDP growth rate as a
predictor, he could come up with a model to forecast the energy use in a certain region. In model
4, that the coefficient
1
equals 0.56 and
4
equals -2.61e-05 means a 1% increase in GDP
growth rate can lead to 0.56 - 2.61e-05Y percent change in the growth rate of energy
consumption. The magnitude of the effect depends on level of GDP per capita.
Population growth rate (G
P
) and research and development expenditure (T) variables seem to
perform inconsistently throughout the models. The G
P
, for instance, is only significant in model
Economic Growth and Energy Consumption

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2 and 4 while the T variable is only significant in model 3. These two variables need more
examination in order to come up with a conclusion regarding their impact on energy
consumption growth rate prediction.
In four model above, the intercept illustrates the energy use growth rate given all explanatory
variables equal zero. In this context, the intercept has some economic meanings. If everything
else equals zero, the energy use growth rate can still be negative, zero or positive due to other
factors such as weather condition. Also, the GDP growth rate, the population growth rate and the
research and development expenditure could be zero in reality.
Model (4), with R-squared (R
2
) of 0.40, explains 40% of the energy use growth. Besides, the
standard error of regression (SER) of about 3.81 illustrates that the typical error of the regression
is about 3.8%, which is quite large regarding energy use growth rate. These two factors suggest
that even though the model (4) has involved many variables, it has not effectively predicted the
growth of energy demand.
Overall, the regression result of my paper is not surprising at all. The empirical examination
in my model partly explains how Perkins could use data related to economic growth (a boom in
Javas economy) to forecast future energy demand and then convinced local government to take
the loans provided by Washington to build more electrical plants.
5. Summary and discussion
Given the empirical results of the models above, I have some base to believe that economic
growth rate plays some role in predicting energy consumption of a certain region or country.
Nevertheless, I also realize that there are a lot of shortages in my models regarding internal and
external validity.
Economic Growth and Energy Consumption

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Firstly, of about 250 countries around the world as the sample size, there are a lot of other
factors affecting the energy consumption prediction that have not been taken into account in my
models such as weather conditions, political events, wars and disasters, etc. Therefore, excluding
these variables in the regression equation may lead to omitted variable bias in the estimation.
Furthermore, there is possible the simultaneous causality bias in my prediction as well. What if
energy consumption is a predictor of economic growth? These issues undermine the internal
validity of my models.
There are also caveats about the external validity of this papers result. The countries in the
sample have different economic, social and cultural conditions. Also, the data collected is at
national level, which means that the research outcomes could be very different when applying to
smaller regions such as Java island. The models, therefore, cannot be applied to smaller regions
energy use prediction.
In sum, even though there are a lot of problems with my models, I have been able to visualize
how Perkins used econometric knowledge to estimate the energy consumption in Java island.
The real-world problem could be more and more complicated, however this paper gives an
interesting result that may require more empirical examination.
Bibliography
(2014). BP Energy Outlook 2035 booklet. BP.
(2014). The World Factbook. Central Intelligent Agency.
(2014). World Bank database. World Bank.



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Appendix

Model 1: OLS, using observations 1-252 (n = 161)
Missing or incomplete observations dropped: 91
Dependent variable: Energy_growth
Heteroskedasticity-robust standard errors, variant HC1

Coefficient Std. Error t-ratio p-value
const -0.528964 0.719093 -0.7356 0.46306
Growth_rate 0.609657 0.128265 4.7531 <0.00001 ***

Mean dependent var 2.007064 S.D. dependent var 5.419510
Sum squared resid 3962.004 S.E. of regression 4.991819
R-squared 0.156908 Adjusted R-squared 0.151606
F(1, 159) 22.59208 P-value(F) 4.45e-06
Log-likelihood -486.2987 Akaike criterion 976.5974
Schwarz criterion 982.7602 Hannan-Quinn 979.0998


Model 2: OLS, using observations 1-252 (n = 160)
Missing or incomplete observations dropped: 92
Dependent variable: Energy_growth
Heteroskedasticity-robust standard errors, variant HC1

Coefficient Std. Error t-ratio p-value
const -0.972258 0.706063 -1.3770 0.17047
Growth_rate 0.550357 0.142383 3.8653 0.00016 ***
Population_growth 0.526448 0.277328 1.8983 0.05949 *

Mean dependent var 2.028699 S.D. dependent var 5.429546
Sum squared resid 3890.258 S.E. of regression 4.977822
R-squared 0.170046 Adjusted R-squared 0.159473
F(2, 157) 19.54649 P-value(F) 2.63e-08
Log-likelihood -482.3147 Akaike criterion 970.6294
Schwarz criterion 979.8550 Hannan-Quinn 974.3756








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Model 3: OLS, using observations 1-252 (n = 63)
Missing or incomplete observations dropped: 189
Dependent variable: Energy_growth
Heteroskedasticity-robust standard errors, variant HC1

Coefficient Std. Error t-ratio p-value
const 0.484591 1.39761 0.3467 0.73003
Growth_rate 0.433689 0.192969 2.2475 0.02836 **
Population_growth 0.471394 0.363972 1.2951 0.20032
R_D_Expenditure -1.6824 0.507951 -3.3121 0.00158 ***

Mean dependent var 0.170015 S.D. dependent var 4.761724
Sum squared resid 936.9978 S.E. of regression 3.985137
R-squared 0.333472 Adjusted R-squared 0.299581
F(3, 59) 13.23407 P-value(F) 1.03e-06
Log-likelihood -174.4288 Akaike criterion 356.8577
Schwarz criterion 365.4302 Hannan-Quinn 360.2293



Model 4: OLS, using observations 1-252 (n = 63)
Missing or incomplete observations dropped: 189
Dependent variable: Energy_growth
Heteroskedasticity-robust standard errors, variant HC1

Coefficient Std. Error t-ratio p-value
const 0.235585 1.39615 0.1687 0.86659
Growth_rate 0.555642 0.222857 2.4933 0.01553 **
Population_growth 0.947625 0.381055 2.4868 0.01579 **
R_D_Expenditure -0.883298 0.552252 -1.5994 0.11516
Interaction -2.61189e-05 8.87845e-06 -2.9418 0.00468 ***

Mean dependent var 0.170015 S.D. dependent var 4.761724
Sum squared resid 842.1129 S.E. of regression 3.810405
R-squared 0.400968 Adjusted R-squared 0.359655
F(4, 58) 11.96927 P-value(F) 3.71e-07
Log-likelihood -171.0657 Akaike criterion 352.1314
Schwarz criterion 362.8470 Hannan-Quinn 356.3459