Income, energy and the role of energy efficiency governance

Understanding the relationship between income and energy consumption is essential for the correct design of energy policy. Many studies have assessed this relationship, but a careful treatment of two-way causality must be carried out to obtain unbiased estimates. For a set of 32 OECD countries, we construct an energy efficiency governance index (EEGI) for the period between 2000 and 2015. We propose an instrumental variable approach that draws on this index in order to control for two-way causality and characterize the aforementioned relationship. The EEGI affects growth only through energy consumption, favoring a more efficient use of energy in the production process and, thus, fostering growth. The elasticity between (energy-governance-driven) energy consumption and income growth is close to unity, and is almost twice that commonly found in the literature. For the other direction of causality, we construct an adjusted income growth series in which the response of income to energy consumption is ruled out. The resulting elasticity is negative (around -3.0), whereas in the literature it is usually negative. Therefore, energy consumption driven by improvements in energy governance is good for growth, while income growth enhances energy efficiency. Since energy consumption is the main driver of carbon emissions in OECD countries, energy governance could play an essential role in decoupling carbon emissions from GDP growth.