Energy Abundance & Economic Growth

Economic growth in the modern world is fueled by energy. Although the total size of the economy tends to grow faster than total energy consumption, the two nonetheless trend together over the long run. This raises an important research question: Does economic growth cause an increase in energy consumption, or does an increase in energy availability cause an increase in economic activity, or both?

The question has important policy implications. Suppose GDP growth causes increased energy consumption, but isn’t dependent on it. In this view, energy consumption is a kind of luxury good (like jewellery), the consumption of which arises from increased wealth. If policymakers wanted to, they could restrict energy consumption without impinging on future economic growth. The alternative view is that energy is a limiting factor, or essential input, to growth. In that framework, if energy consumption is constrained by policy, future growth will also be constrained, raising the economic costs of such policies. If both directions of causality exist, it still implies that energy restrictions will have negative effects on future growth. The final possibility is that energy consumption and GDP are unrelated.

Statistical evidence can be used to establish correlations, but we are asking a question about causality, and as the saying goes, one does not imply the other. In recent decades, new statistical methods have been developed that allow for investigation of a particular kind of causality, and these methods have been applied to the energy-GDP question. The first purpose of this report is to explain what these methods are and how they have been used to examine the connection between growth and energy consumption around the world. The picture that has emerged is that growth and energy either jointly influence each other, or that the influence is one-way from energy to GDP, but in either case the evidence now points away from the view that energy use can be restricted (or, equivalently, prices artificially increased) without constraining future growth. Also, out of all countries studied, Canada has yielded some of the most consistent evidence on this, in that studies done under a variety of methods and time periods have regularly found evidence that energy is a limiting factor in Canadian economic growth.

The second purpose of this paper is to discuss what the evidence indicates for Canada, including new evidence we provide based on our ongoing research on this topic. Our examination of Canadian data, applying the most modern time series econometric methods available, leads us to conclude that energy use in Canada is not a mere by-product of prosperity but a limiting factor in growth: real per-capita income is constrained by policies that restrict energy availability and/or increase energy costs, and growth in energy abundance leads to growth in GDP per capita. Thus, policies favouring the abundant availability of energy are important for sustaining strong economic growth, and policies that deliberately limit energy availability will likely have negative macroeconomic consequences.

These considerations are important to keep in mind as policymakers consider initiatives (especially related to renewable energy mandates, biofuels requirements, and so forth) which explicitly limit energy availability. Jurisdictions such as Ontario have argued that such policies are consistent with their overall strategy to promote economic growth. In other words, they assert that forcing investment in wind and solar generation systems— while making electricity more expensive overall—will contribute to macroeconomic growth. The evidence points in the opposite direction. Policies that engineer increased energy scarcity are likely to lead to negative effects on future GDP growth.