Relationship Between Economic Growth and Energy Intensity

1.1 Background and rationale of research

According Safaynikou and Shadmehri (2014), the foundation of energy views can be discussed within two general frameworks; neoclassic economists and biologist economists. Biologist economists consider energy as the dominant factor in the production function and regard it as the main factor of economic growth and consider such factors as labor force and capital as mediating factors. On the other hand, neoclassic economists maintained energy play relatively insignificant role in economic production and growth and consider it as a mediating factor which becomes important along with capital, labor force and land. Overall, it can be said despite of disagreement about the effects of energy on economic growth, high important effect of energy on economic production and growth is vital though the amount of energy used is differ based on the industries allocation. Sustainable of energy is vital for continuance of growth development and wellbeing. When a country developed a good and advance energy, a development will occur and as a result, it will impede the economic growth. Hence, lessening the intensity of energy use in developed and developing countries is considered an important element in the world’s ability to grow sustainably. Likewise, reducing energy intensity is considered a practical solution to many of today’s common challenges including global energy shortages; mitigating against further changes in the climate; and health impacts of local air and water pollution (Elliot et al; 2014). It is necessary to determine the antecedents that associated with energy intensity especially in the emerging countries whereby the economy in those countries growing very rapidly so too does the demand for energy is high.

1.2 The relationship between economic growth and energy intensity

According to Aziz (2011) a shortage of energy may negatively affect economic growth or may cause poor economic performance, leading to a fall in income. Meanhwile Safaynikou and Shadmehdi (2014) argue that a maximum growth rate is considered for the economy and achieving growth rate requires energy consumption in a high volume, and thus great investment is needed for provision of energy in the future. According to Antweiler, Copeland, and Taylor (2001) and Herrerias et al. (2012), the industrial sector is known to be energy intensive while the energy intensity of the service sector is relatively low. The composition effect tends to lead to a rise in energy intensity followed by a decline when income grows and the economy shifts towards the service sector (Stern, 2004; Elliott et al., 2013. This development is strengthened by the technique effect in that richer countries can afford a technology shift toward more energy efficient techniques. The composition and technique effect may be so strong that they outperform the scale effect.

1.3 The relationship between financial development and energy intensity

Developed financial institutions and capital markets can provide an opportunity to lend capital to the renewable energy sector, and provide debt as well as equity financing in funding green renewable energy projects, respectively (Dasgupta et al; 2004). Good financial development makes it possible to offer credits for environmentally friendly projects at low financing costs. Thus, financial development can serve as an incentive for increased energy substitution (which reduces energy consumption), while at the same time affording lending capital to the energy industries. Calderon et. al., (2004) on the other hand found that mature institutions and policy credibility allowed some emerging market economies to implement stabilizing countercyclical policies. These policies reduced business cycles and economic fluctuations which led to more predictability power. This predictive confidence provided a better investment environment that resulted in more rapid growth.

1.4 The nexus of FDI, trade openness, globalization and energy intensity

There is a consistent opinion that FDI could affect the energy consumption intensity by improving the technology of importing countries. Borensztein, E. (1998) had presented the opinion that FDI could improve the enterprise productivity by adopting advanced technology and management. In a study Alfaro et al. (2010) noted that FDI could enhance the energy utilization efficiency of the recipient country by reorganizing of production, technology diffusion, and other ways. However, this will be conditioned by the recipient country’s absorptive competence. The findings of Pu-yang et al. (2011) indicate that FDI can promote energy efficiency, decrease energy consumption intensity. Tang (2009) opines that the influx of FDI is inducing energy consumption through the expansionary of industrialization, transportation and manufacturing sectors development while energy is required to support the manufacturing process. Hence, FDI may lead to technology innovation by local firms, which can help reduce energy use (Alfaro, Chanda, Kalemli-Ozcan, & Sayek, 2004, 2006; Bailliu, 2000; Hermes & Lensink, 2003). Herrerias at al. (2012) mentioned that international trade has altered the relative profitability of certain industries – particularly heavy industry – which would explain the gradual move away from energy-intensive heavy industries (structural change). On the other hand, market reforms may also lead to energy-saving innovations, thus raising energy productivity at the firm level (technological progress).

The process of global integration represents the “widening and deepening of the international flows of trade, capital, technology and information within a single integrated market (Petras and Veltmeyer, 2001).” Gaston and Nelson (2008) argue that globalization is transformative, where it reconstitutes and restructures the economic and political configuration of the world. Norris (2000) indicates that globalization erodes “national boundaries, integrating national economies, cultures, technologies, and governance, producing complex relations of mutual interdependence.” Hence, the process of globalization, which integrates the world economy into a single system, may possibly influence energy exports (Chang et al; 2013)

1.5 Is energy price matters?

Generally, the low energy price will consequently increase the energy consumption trough energy demand. This is due to people will use the benefit to consume more energy to travel to one place and to channel it to industries to produce more goods and services (Wong et al; 2013). To energy economists, oil price shocks should provide incentive to many economies, especially those without oil reserves, to use oil more efficiently either through more cautious oil consumption or the development of new technology that uses alternative sources of energy. While oil price shocks encourage more efficient use of oil and promote substitution away from oil to other alternative energy resources, economic growth during economic boom stimulates oil consumption. Study by Darrat et al. (1996) reveals that oil shocks are not conducive to recessions and that adjustment in oil prices and output produce changes in oil consumption.

1.2 Problem statement

Chang (2014) argues that growing efficiency of financial intermediation will promote to household and industries lending and thus, will promote to higher usage of energy consumption through the purchase of “large-ticket” items for instances, new electric appliances and machinery. Second view argues that good financial development makes it possible to promote credit for environmentally friendly project at low cost. The author (Dasgupta et al; 2004) argue that developed financial institution can provide a chance to lend capital to the renewable energy sector. Furthermore, financial development has a direct impact on energy consumption (e.g. Islam et al., 2013; Sadorsky, 2010, 2011; Shahbaz and Lean, 2012).

Apart from the views above, according to Ang (2008), institutional instability can also affect the organization of the financial sector and consequently, increase the cost of transactions and causes the problems within the payments system. These transaction costs, which are real resources leads to misallocation of the resources and hence the rate of economic growth may suffer. Claessens et al. (2012) provided a comprehensive empirical characterization of the linkages between key macroeconomic and financial variables around business and financial cycles; the main results indicate that the duration and amplitude of recessions and recoveries are often shaped by linkages between business and financial cycles. Overall, they found movements in house prices to be most closely associated with the depth of recessions and strength of recoveries. Since a developed financial sector reduces the cost of borrowing and promotes investment activities (Shahbaz, 2009; Shahbaz et al., 2010) and also lowers energy emissions by increasing efficiency in the energy sector, it is doubtful whether the presence of financial instability will promote towards the efficiency usage of energy demand.

Up to date, there seems to be little analysis of the globalization effects on the energy intensity though the effects are seen as either very negative or very positive depending on the methodological and ideological inclinations of the advocate or critic. On the one hand, international agencies and many mainstream economists view globalisation as an inevitable and positive development, as summarised by Smith (2000):

“The neoliberal view of globalisation can be summarised in three statements. First, technological developments in the ‘new economy’ have granted both finance and productive capital an unprecedented ability to escape national boundaries. Second, this historical development has the potential to benefit all the groups in the world economy ultimately, whatever the short-to-medium-term costs of adjustment might be. Third, governments, which are powerless to stop this development in any case, ought to enforce property rights, maintain the value of their currencies, and then get out of the way” (p. 120).

But while engaging in trade and investment activities, this also requires consumption of huge quantum of energy which releases more carbon dioxide Thus, the effect of globalization depends on the net effect of openness on economic growth as there could be a net effect of energy consumption on economic grwoth and also the effect of openness on energy consumption. Globalization accelerates the structural change by altering the industrial struc- ture of countries as industries orient toward satisfying foreign demand for their products and this gives rise to increased resource use and atmospheric pollution levels. This in turn intensifies the market failures and policy distortions that may spread and exacerbate environmental damage (Nanthakumar et al. 2014).

1.3 Motivation of the research

It is agreed that financial development has a direct impact on energy consumption (e.g. Islam et al., 2013; Sadorsky, 2010, 2011; Shahbaz and Lean, 2012). Shahbaz (2013). However, as discussed earlier, the empirical research of financial instability towards energy intensity is remained vague. This research is motivates to fill the gap of the findings of Shahbaz (2013) whereby he investigates how the financial instability affect environmental degradation in Pakistan and he suggests that the presence of financial instability increases environmental degradation. Hence, it is essential to investigate on how the financial instability will affect the energy intensity due to during the periods of financial instability, firms are weaker financially due to less availability of funds and firms do less care about environment and, enhance their output as well as raise their profits, at the cost of environmental degradation. Furthermore, developed financial sector reduces the cost of borrowing and promotes investment activities (Shahbaz, 2009; Shahbaz et al., 2010) and also lowers energy emissions by increasing efficiency in the energy sector, thus, it is important to investigate the efficiency of energy used during the period of financial instability.

Chang et al. (2013) suggest that higher energy exports contribute to higher growth rates in the period of rising global integration. Chung and Gillespie (1998) point out that the environmental effects of globalization can be positive or negative. They will be positive if, through the diffusion of cleaner technologies and the reduction of poverty, “globalization could help uncouple economic growth from pollution generation and resource consumption” (p. 8). Indeed, as Jones (1998) argues, since globalization will lead to higher rates of technology development and diffusion, this will reduce the costs of the development of new technologies which will have environmental benefits for all countries: for the developed ones, it frees up resources to devote to more radical solutions to environmental problems; for the newly industrializing, it speeds up the diffusion of cleaner production technologies as part of the technology transfer activities of globalizing multinationals. Hence, this research is motivate to determine whether the presence of globalization will positively or negatively affects the efficiency of energy demand particularly in emerging countries whereby the energy demand is extensive in those countries.

According to Climatescope (2014) report, it suggests that renewable technologies can be just a cost competitive solution in developing countries just as they are in the industrialised world based on 55 emerging markets in Africa, Asia, Latin America and the Caribbean. It is added that clean energy technologies are no longer out of reach for developing countries, which are home to some of the most extraordinary wind, solar, geothermal, biomass, hydro and other natural resources. Hence, this research is motivate to investigate the efficiency of energy demand based on the selected samples of emerging markets.

1.4Objectives of the research

The research aim of this study is to investigate the linkages between macroeconomic determinants and energy price on energy intensity with the presence of financial instability and globalization to the emerging markets for the period of 1980 – 2013. Specific objectives of this research are:

(1)To determine whether the presence of financial instability would affect energy intensity in short and long run by using heterogenous panel data approach

(2)To determine whether globalization will impact on energy intensity in short and long run by using heterogenous panel data approach

(3)To explore the possible existence of causality effects between the energy intensity, energy price, macroeconomic determinants in the presence of financial instability and globalization

1.4 Research Questions

The related questions that need to be addressed are:

(1)Does the occurrence of financial instability would affect energy intensity in short run and long run period?

(2)Is there any possibility of globalization will affect the energy intensity in short run and long run period?

(3)Are there any causality effects running between energy intensity, energy price, macroeconomic determinants in the presence of financial instability and globalization?