This paper examines the long-run relationship between energy consumption and real GDP, including energy prices, for 25 OECD countries from 1981 to 2007. The distinction between common factors and idiosyncratic components using principal component analysis allows to distinguish between developments on an international and a national level as drivers of the long-run relationship. Indeed, cointegration between the common components of the underlying variables indicates that international developments dominate the long-run relationship between energy consumption and real GDP. Furthermore, the results suggest that energy consumption is price-inelastic. Causality tests indicate the presence of a bi-directional causal relationship between energy consumption and economic growth

Ansgar Belke

Christian Dreger

Frauke Dobnik

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Energy consumption and economic growth: New insights into the
cointegration relationship
Ansgar Belke a,b,c, Frauke Dobnik a,d,⁎, Christian Dreger b,e
a Department of Economics, University of Duisburg-Essen, Universitätsstrasse 12, 45117 Essen, Germany
b German Institute for Economic Research (DIW Berlin), Mohrenstrasse 58, 10117 Berlin, Germany
c Institute for the Study of Labour (IZA), Schaumburg-Lippe-Strasse 5–9, 53113 Bonn, Germany
d Ruhr Graduate School in Economics (RGS Econ), Germany
e Department of Economics, University of Frankfurt (Oder), post office box 1786, 15207 Frankfurt (Oder), Germany
a b s t r a c ta r t i c l e i n f o
Article history:
Received 8 June 2010
Received in revised form 10 December 2010
Accepted 6 February 2011
Available online 21 February 2011
JEL classification:
C33
O13
Q43
Keywords:
Energy consumption
Panel unit roots
Panel cointegration
Vector error-correction models
Granger causality
This paper examines the long-run relationship between energy consumption and real GDP, including energy
prices, for 25 OECD countries from 1981 to 2007. The distinction between common factors and idiosyncratic
componentsusingprincipal component analysis allows todistinguishbetweendevelopments onan international
and a national level as drivers of the long-run relationship. Indeed, cointegration between the common
components of the underlying variables indicates that international developments dominate the long-run
relationship between energy consumption and real GDP. Furthermore, the results suggest that energy
consumption is price-inelastic. Causality tests indicate the presence of a bi-directional causal relationship
between energy consumption and economic growth.
© 2011 Elsevier B.V. All rights reserved.
1. Introduction
The question of whether or not energy conservation policies affect
economic activity is of great interest in the international debate on
global warming and the reduction of greenhouse gas emissions.
Although the causal relationship between energy consumption and
economic growth has beenwidely studied, no consensus regarding this
so-called energy consumption-growth nexus has yet been reached. The
direction of causality is highly relevant for policymakers. For instance, if
causality runs from energy consumption to economic growth, energy
conservation policies that have the aimof reducing energy consumption
may have a negative impact on an economy's growth. The literature
proposes four different hypotheses regarding the possible outcomes
of causality (Apergis and Payne, 2009a,b).1 The growth hypothesis
suggests that energy consumption is a crucial component in growth,
directly or indirectly as a complement to capital and labour as input
factors of production. Hence, a decrease in energy consumption causes a
decrease in real GDP. In this case, the economy is called ‘energy
dependent’ and energy conservation policiesmay be implementedwith
adverse effects on real GDP. By contrast, the conservation hypothesis
claims that policies directed towards lower energy consumption may
have little or no adverse impact on real GDP. This hypothesis is based on
a uni-directional causal relationship running from real GDP to energy
consumption. Bi-directional causality corresponds with the feedback
hypothesis, which argues that energy consumption and real GDP affect
each other simultaneously. In this case, policy makers should take into
account the feedback effect of real GDP on energy consumption by
implementing regulations to reduce energy use. Finally, the neutrality
hypothesis indicates that reducing energy consumption does not affect
economic growth or vice versa. Hence, energy conservation policies
would not have any impact on real GDP.
In consideration of such a pure statistical causality analysis with a
few variables it should be noted that the policy implications of causality
between energy consumption and real GDP are not straightforward.
Energy conservation policies cannot sensibly be constituted without
considering economic or environmental factors such as energy supply
Energy Economics 33 (2011) 782–789
⁎ Corresponding author at: Department of Economics, University of Duisburg-Essen,
Universitätsstrasse 12, 45117 Essen, Germany. Tel.: +49 201 183 4912; fax: +49 201
183 4181.
E-mail address: Frauke.Dobnik@uni-due.de (F. Dobnik).
1 The different directions of causality between energy consumption and economic
growth have been described in many previous studies. Also, the phrase ‘neutrality
hypothesis’ has often been used. The denotations of the other causal relations were
proposed by Apergis and Payne (2009a,b).
0140-9883/$ – see front matter © 2011 Elsevier B.V. All rights reserved.
doi:10.1016/j.eneco.2011.02.005
Contents lists available at ScienceDirect
Energy Economics
j ourna l homepage: www.e lsev ie r.com/ locate /eneco
infrastructure, energy efficiency considerations or institutional con-
straints (Mahadevan and Asafu-Adjaye, 2007). Hence, the formulation
of an efficient energy policy is more complicated than empirical results
might suggest. For instance, energy conservation policies accomplishing
a reduction in energy consumption due to an improved energy
efficiency may raise the productivity of energy consumption, which in
turn may stimulate economic growth. Thus, a shift from less efficient
energy sources tomore efficient and less pollutingoptionsmayestablish
a stimulus rather than an obstacle to economic growth (Costantini and
Martini, 2010). The other way around, bad energy supply infrastructure
or other supply side disruptions decreasing energy consumption could
indeed induce an adverse impact on economic growth. Further, high
substitutability between energy and other input factors on the
production side can explain possible economic growth without a
considerable increase in energy consumption. Therefore, the empirical
results of causality analyses should be interpreted with caution.
Our analysis of the relationship between energy consumption and
economic activity is based on a sample of 25 OECD countries from 1981
to 2007 and uses recently developed panel-econometric methods. We
explore an additional channel of causality by introducing energy prices.
As energy prices have been neglected in many previous studies, the
long-run parameters and the evidence of causality may be biased, see
Masih and Masih (1997) and Asafu-Adjaye (2000). But in contrast to
these two studies, we examine the original energy price index rather
than the consumer price index (CPI) as a proxy. Income and price
elasticities provide policy makers a suggestion of the extent to which
prices need to increase, in the form of energy taxes, in order to reduce
energy consumption and the potential for the market to conserve
energy (Lee and Lee, 2010). Additionally, energy companies need this
information to design their demand management policies. But only a
few papers have estimated income and price elasticities for energy
consumption in a panel framework. Furthermore, the long-run
equilibrium relationship is studied in both directions, i.e. with either
energy consumption or real GDP as a dependent variable (Costantini
and Martini, 2010).
The innovative contribution of our paper is to determine the long-
run relationship between energy consumption, real GDP and energy
prices in more detail. In contrast to other studies concerning the
energy consumption-GDP growth nexus, we distinguish between
national and international trends as potential drivers of the long-run
equilibriumbetween energy consumption, real GDP and energy prices.
To analyse these issues, each variable is decomposed into common and
idiosyncratic components. The idiosyncratic component is the part of a
variable that is driven by national developments, whereas the
common component represents international trends in the evolution
of the variables. These might, however, have a different relevance for
individual countries. Taking this decomposition as a starting point,
cointegration between the common components means that the
common components of energy consumption, real GDP and energy
prices move together in the long run and do not deviate permanently
from one another. Hence, cointegration between the common
components suggests that the relationship between these variables
depends to a great extent on international developments. Instead,
cointegration between idiosyncratic components refers to develop-
ments relevant exclusively on the national level (Dreger and Reimers,
2009). Depending on the results of the cointegration tests, this
distinction has important implications for policy makers. If the
common components cointegrate, national energy policies may not
have a large impact on economic growth. Indeed, this paper delivers
empirical evidence that energy consumption, real GDP and energy
prices are cointegrated in their common factors, but not in their
idiosyncratic components.
The remainder of this paper is organised as follows. Section 2
briefly reviews the literature related to the causal relationship
between energy consumption and economic growth. Section 3
presents the data, discusses the econometric methods and presents
the empirical results. Section 4 provides conclusions and policy
implications.
2. Literature review
The empirical literature provides mixed and conflicting evidence
with respect to the energy consumption-growth nexus. This discrep-
ancy in results is due largely to the use of different econometric
methods and time periods, besides country-specific heterogeneity in
climate conditions, economic development and energy consumption
patterns, among other things. From a methodological perspective,
four generations of contributions can be identified. First generation
studies applied a traditional vector autoregression (VAR)model in the
tradition of Sims (1972). For example, the seminal work of Kraft and
Kraft (1978), using a VARmodel, found evidence in favour of causality
running from income to energy consumption in the United States for
the period 1947–1974. Further, studies of the first generation
examined the direction of causality assuming stationarity of the
underlying variables. By contrast, second generation studies
accounted for non-stationarity in the data and performed cointegra-
tion analysis to investigate the long-run relationship between energy
consumption and growth. This literature, based on the Engle and
Granger (1987) two-step procedure, studied pairs of variables to
check for cointegration relationships and used estimated error-
correction models to test for Granger causality. Third generation
studies used multivariate estimators in the style of Johansen (1991).
Johansen's multivariate approach also allows for more than two
variables in the cointegration relationship. Finally, fourth generation
studies employ recently developed panel-econometric methods to
test for unit roots and cointegration relations. This literature estimates
panel-based error-correction models to perform Granger causality
tests.2 According to our analysis of 25 OECD countries Table 1
summarises preferably all studies of the last five years on developed
countries and their empirical results.3 The ambiguous evidence of the
empirical literature on the causal relationship between energy
consumption and economic growth can already be seen from this
recent studies on developed countries. Panel data analyses of OECD
countries, however, all indicate bi-directional causality.
Most of the studies dealing with the energy consumption-growth
nexus focus on production side models, which often include capital
stock and labour in addition to energy consumption and GDP. If one
concentrates on energy demand, trivariatemodelswith energy prices as
an additional variable should be used (see Oh and Lee (2004b)). The
studies by Masih and Masih (1998), Asafu-Adjaye (2000), Fatai et al.
(2004) as well as Mahadevan and Asafu-Adjaye (2007) take the
consumer price index (CPI) as a proxy of the energy price. However, as
the CPI is known not to capture the energy price very well, we employ
the real energy price index, such as Lee and Lee (2010) and Costantini
and Martini (2010). Masih and Masih (1998) and Asafu-Adjaye (2000)
previously used the vector error-correction model (VECM); Fatai et al.
(2004) applied the autoregressive distributed lag (ARDL) approach; and
Mahadevan and Asafu-Adjaye (2007), Lee and Lee, (2010) as well as
Costantini and Martini (2010) used a panel vector error-correction
specification for the trivariate model.
In this paper, we study the cointegration property in more precise
terms within a panel-econometric framework. Firstly, in order to
distinguish between national and international trends that might drive
the overall cointegration relationship, each variable is separated into
common and idiosyncratic components by a principal component
analysis. As a second step,we test common and idiosyncratic components
2 For a detailed overview of the empirical literature on the causal relationship
between energy consumption and economic growth see the recent surveys by Ozturk
(2010) and Payne (2010).
3 Although many of the listed studies also report results for developing countries,
we only show their results with respect to developed countries to save space.
783A. Belke et al. / Energy Economics 33 (2011) 782–789



Energy Consumption and Economic Growth: New Insights into The Cointegration Relationship

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Energy Consumption and Economic Growth: New Insights into The Cointegration Relationship

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