Energy prices and economic growth in the long run: Theory and evidence

In this paper, we attempt to derive and test the role of energy prices on economic growth. We first developed a two-sector endogenous growth model, based on J Polit Economy 1991; 99:500–521. We modified the model such that consumption goods sector uses energy as an input along with capital. The model allows us to show that the growth rate of energy price has a negative effect on the growth rates of energy use and real GDP. Following this, derived theoretical relationships between energy prices and economic growth and energy consumption were tested empirically using error-correction based panel cointegration tests and panel Autoregressive Distributed Lag (ARDL) approach. We applied this methodology on data of composite energy prices, GDP per capita and energy consumption per capita for sixteen countries for the period between 1978 and 2011. We found significant cointegration between energy prices and real GDP per capita, as well as between energy prices and energy consumption per capita. Moreover, long-run estimates reveal negative and significant effects of composite energy prices on both GDP per capita and energy consumption per capita. We suggest that increasing the share of renewable energy sources in energy consumption would help policy-makers to control permanent long-term increases in consumer energy prices, in turn leading to an increase in economic growth, and hence in welfare. This paper contributes to the literature by highlighting the existence of a previously neglected welfare-improving channel of renewable energy.