The impact of increased efficiency in the industrial use of energy: A computable general equilibrium analysis for the United Kingdom☆
Introduction
Governments and environmental pressure groups across the world are advocating energy efficiency programs for either energy security or environmental reasons (Cabinet Office, 2001, Carbon Trust, 2003, Department of Environment Food and Rural Affairs, 2005, European Environment Agency, 1999, Nordic Council of Ministers, 1999, Schutz and Welfens, 2000). Whilst the conventional wisdom is that improving energy efficiency will lower energy use, there is an extensive debate in the energy economics/policy literature on the actual impact of such improvements. This debate focuses on the notion of “rebound” effects, according to which the expected beneficial impacts on energy intensities are partially offset as a consequence of the economic system's responses to the fall in the effective price of energy services that accompany the improvement in energy efficiency. The “Khazzoom–Brookes postulate” (Saunders, 1992) asserts an extreme form of this: that improvements in energy efficiency can actually increase the demand for energy, a phenomenon initially identified by Jevons (1865) and now known as “backfire”.
There is general agreement that some degree of rebound is to be expected, so that if, for example, a 5% improvement in energy efficiency in a particular use will generate energy savings of 3%, rebound would be 40%.1 Of course, the key question is the pragmatic one: how big is this rebound effect likely to be? Empirical work has concentrated on measuring rebound effects in consumer services (Dufournaud et al., 1994, Greening et al., 2000, Small and Van Dender, 2005, Zein-Elabdin, 1997). Moreover, existing studies generally focus on the “direct” rebound effects. This restricts the analysis solely to the energy requirements to provide the consumer services to which the efficiency improvement directly applies. Less frequently studied are the “indirect” and “economy-wide” effects that are associated with the relative price, output and income effects that will affect the consumption and production in other energy using industries. This decomposition of rebound into direct, indirect and economy-wide effects is first made by Greening et al. (2000), who also point to a shortage of empirical studies on the “non-direct” rebound effects.
A recent UK House of Lords (2005, p. 29) report sums up the present position as follows:
Absolute reductions in energy consumption are thus possible at the microeconomic level. However, this does not mean that an analogy can be made with macroeconomic effects. Apart from anything else, the substitution effects observable at the macroeconomic level cannot be replicated by households, where demand for a range of goods is relatively inelastic… a business on the other hand, could respond to cheaper energy by deliberately increasing consumption — using a more energy intensive process, which would allow savings to be made elsewhere, for instance in manpower.
The House of Lords report seems to be making two points here. First, that energy savings in production sectors are likely to have stronger indirect and economy-wide impacts than energy saving in consumption activities. Second, that energy substitution possibilities might be substantially greater in production than consumption.
In this paper we wish to tackle the question: how large are the rebound effects likely to be for general improvements in energy efficiency in production activities in a developed economy? Specifically, does an increase in the efficiency by which energy is used in industrial production processes raise or lower the consumption of energy by industry? Further, to what extent does this response differ across industries? The method that we adopt is to undertake simulations with an economy–energy–environment computable general equilibrium (CGE) model for the UK.
Using CGE modeling to analyse this problem has both strengths and weaknesses. A key strength is that CGE models have a strong grounding in conventional economic theory. They give an appropriate treatment of the supply-side changes resulting from supply-side policies and allow the net impacts of energy policy to be considered against a clear “counter-factual”. CGE models are also able to deal numerically with the simultaneity prevalent where major economic changes occur and to identify the orders of magnitude, not only the direction, of the resulting economic effects. However, the approach does also have weaknesses. One is the data required to operationalise the model: a set of multi-sectoral accounts is needed, together with a large number of behavioural and technical parameters. Further, Sorrell et al. (2004) argue that for the specific case of energy efficiency, the conventional neoclassical relationships which CGE models typically use might fail to capture some of the significant barriers to the penetration of new technologies. Finally, the particular assumptions made about the CGE model closure make comparisons across models difficult. For example, changing the assumption about the operation of the labour market can generate significant variation in the energy use results.
Our key conclusion is that for our central case simulation, a general, across the board, improvement in efficiency in energy use in UK production sectors has rebound effect of the order of 55% in the short run and 30% in the long run, but no backfire (no increase in energy use). Sensitivity analysis suggests that this central case result is particularly sensitive to the imposed elasticities of substitution in the production hierarchy. However, the results also vary significantly with the nature of the assumptions made concerning the labour market, the way in which increased government revenues are recycled back into the economy and the time period under consideration.
In Section 2 we briefly summarise previous theoretical discussions and sketch our own analysis of the likely system-wide ramifications of a stimulus to industrial energy efficiency. We conclude, as have many others (e.g., Saunders, 2000b), that the extent of rebound and backfire is an empirical issue. In Section 3 we describe our economy–energy–environment computable general equilibrium (CGE) model of the UK, UKENVI. In Section 4 we present the results of simulating an across the board stimulus to energy efficiency in production sectors and in Section 5 we discuss the results of our sensitivity analysis. Section 6 outlines the strengths and weaknesses of the CGE modeling approach. Section 7 concludes and offers some recommendations for future research.
Section snippets
Analytical background
It is instructive to provide a brief account of the literature on what has come to be known as the macroeconomic rebound effect. This focuses on the Khazzoom–Brookes postulate, though both Khazzoom (1980) and Brookes (1990) acknowledge Jevons (1865) as being the originator of the basic idea that energy efficiency improvement could lead to an increase in energy demand.
Jevons (1865) is concerned with the possible exhaustion of a finite natural resource, namely coal. Whilst largely an empirical
The UKENVI model
CGE models are now extensively used in studies of the economy–energy–environment nexus at the national (Beauséjour et al., 1995, Bergman, 1990, Conrad, 1999, Conrad and Schröder, 1993, Goulder, 1998, Lee and Roland-Holst, 1997) and regional levels (Despotakis and Fisher, 1988, Li and Rose, 1995). The popularity of CGEs in this context reflects their multi-sectoral nature combined with their fully specified supply-side, facilitating the analysis of economic, energy and environmental policies.
Results of the central case CGE simulations
The disturbance simulated using the UKENVI model is a 5% improvement in the efficiency by which energy inputs are used by all production sectors. Recall that the five energy sectors in UKENVI are coal, oil, gas and renewable and non-renewable electricity. This shock is a one-off permanent step change in energy efficiency, as depicted in Eq. (1). It is introduced in the use of the energy composite good (see Fig. 1). This introduces a beneficial supply-side disturbance, which would be expected to
Sensitivity analysis
Our central case results presented in Table 1 are dependent upon the structural data embedded in the base-year values of the UK SAM. However, they will also be sensitive to the choice of key parameter values in the UKENVI model, the recycling of additional government revenues, additional costs that might accompany energy efficiency improvements and the nature of the labour market. In the next four subsections we outline the effects of varying these assumptions.
The strengths and weaknesses of the CGE modeling approach
What are the major strengths and weaknesses of this form of analysis for this type of problem? First, from a conceptual point of view, a major strength of CGE analysis is that it is grounded in standard economic theory, but can deal with circumstances that are too complex for tractable analytical solutions. As such, CGE analysis is a numerical aid to analytical thought. For example, in the energy efficiency we know that there are a whole range of substitution, income, output and sectoral
Conclusion
The simulations reported in this paper suggest that for the UK, we expect a general, across the board, improvement in efficiency in energy use in production to have significant rebound effects but no backfire. Short-run rebound effects are above 50%, whilst the long-run values are around 30%. Increases in energy efficiency will reduce energy use, but not by the full proportionate amount. Moreover, these impacts will vary across energy types. Most of the rebound effect is captured within the
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The research reported here was funded by the UK Department for Environment Food and Rural Affairs (DEFRA), though the paper also draws liberally on related research which was funded by the EPSRC through the SuperGen Marine Energy Research Consortium (Grant reference: GR/S26958/01). The authors are grateful to Tina Dallman (DEFRA), Allistair Rennie (DEFRA) and Ewa Kmietowicz (DTI) for their discussion and comments.