Directed Technical Change, Capital Intensity Increase and Energy Transition: Evidence from China.

• Author: Wang, Dong

1. INTRODUCTION

   Every stage of the energy life cycle--exploration, extraction, conversion and consumption--is underpinned by the technologies which correspond to different types and grades of fuels (Chakravorty, Roumasset, and Tse 1997). Energy production technology is linked to the capital intesity of the economy, measured by the capital-labor ratio. Advanced energy technologies tend to be adopted by energy suppliers in an economy with relatively high capital intensity, due to the requirement for skilled labour and infrastructure. Three historical examples illustrate this assertion. The first is Cugnot's Fardier. In 1770, a French inventor Nicolas-Joseph Cugnot built a high-pressure steam engine and installed it on a vehicle, but this technology was not successfully adopted until the invention of rails, a capital-intensive infrastructure, developed in British coal mines (Allen 2009, 153). The second example is Jacques de Vaucanson's automated silk loom, which was never used commercially since it was too capital-intensive (Doyon and Liaigre 1967). It is well documented that China Sichuan province was using natural gas as far back as the Han dynasty (200 BCE). However, large-scale use of natural gas did not occur until capital-intensive technologies like turbines, compressors and pipes were developed in capital intensive economies in Europe and the USA after World War II (Smil 2010, 37).

   Energy transition from one form of energy to another requires a change in input proportions between labor and capital (Kander, Malanima, and Warde 2014, 411). For instance, labor demand in coal mining per unit of energy is usually higher than that in nuclear power plants; likewise, the capital intensity of solar power production is relatively higher than that in generating energy from fuelwood. This phenomenon is due to the attributes of each primary energy source including scarcity, power intensity, energy density, safety, the flexibility of use, and cost of conversion (Stern 2010).

   However, technical change in energy production is not neutral but tends to use more capital than labor (Acemoglu 2002). This biased technical change can be driven either by relative factor price changes (the price effect) or by relative factor quantity change, that is, capital intensity increase (market size effect). The relative factor price change will create incentives to develop advanced technologies using the more expensive factor that is--capital--rather than labor. The relative factor abundance change will promote technological progress by using the more abundant factor, that is, capital. In this context, an increase in capital intensity will induce technical change directed to modern energy which is capital intensive. Acemoglu (2002) notes that an increase in the relative abundance of a factor creates technical change biased towards that factor irrespective of the elasticity of substitution between that factor and other factors (as long as it is not equal to one). This is referred to as 'weak induced-bias hypothesis' (Acemoglu 2002). If the elasticity of substitution between capital and labor is sufficiently large, the directed technical change can increase the relative reward to the factor that is abundant, thus making the long-run relative demand curve of factors slope up because of 'increasing return to scale' in the R&D process; this is 'strong induced-bias hypothesis' in Acemoglu (2002). Acemoglu's model implies that technical change in energy transition is biased towards modern energy (that is, capital-intensive energy) when there is capital accumulation relative to labor in a developing economy. Kander, Malanima, and Warde (2013, 411) assert that production technologies for modern energy tend to use more capital and less labor than production technologies for traditional energy. Their analysis is based on the history of European energy transition during the last five centuries. To be more precise, the relative proportions of traditional energy and modern energy production may be in line with an increase in capital intensity in the long run. An increase in capital intensity ultimately determines the direction of energy transition because of directed technical change.

   This paper will explore this potential relationship between energy transition and capital intensity based on annual time series data since the Chinese economic reform was launched in 1978. Since then, China's energy transition has been driven by large-scale investment in the modern energy sector as well as the capital intensity increase of the whole economy. For instance, in 2015, China invested US$103 billion in the domestic renewable and clean energy sector, accounting for one-third of global investment in this sector and two-and-a-half times the amount undertaken by the U.S. In the National 13 (th) Five-year Plan (FYP), renewable energy investment will reach 2.5 trillion Yuan, a 39% increase from the National 12th Five-year Plan (Buckley and Nicholas 2017). Indeed, such large-scale investment directed to modern energy results from the continuing capital deepening, which was brought about by the rapid economic growth over the past four decades. This investment in energy is expected to stimulate capital accumulation, economic growth and induce more innovation in the modern energy sector so that more advanced technologies can be adopted. In this vein, an increase in capital intensity promotes energy transition towards a trajectory of sustainable development. As Lin (2012, 5) states "that sustained economic development is driven by changes in factor endowments and continuous technological innovation." We determine the direction of causality between energy transition and an increase in capital intensity, and whether there is a relationship between them in the long run. Answering these questions is a contribution to the literature on energy transition by providing an in-depth understanding of the underlying mechanism of energy transition in economic development.

   Our conceptual framework is based on the duality theory (Uzawa 1964), endowment structural change model (Ju, Lin, and Wang 2015) and directed technical change model (Acemoglu 2002, Acemoglu et al. 2016). We model the long-run causal relationship between China's energy transition and capital intensity. We do this by conducting the Granger causality test and estimating a Vector Error-Correction Model (VECM). We find that in the long run, China's energy transition is not only in line with capital intensity in the economy, but is also driven by it. The pathway is due to the principle of directed technical change that energy production shifts from low to high capital-intensive modern energy as capital accumulates in the economy. Investment policies for the modern energy sector can stimulate capital deepening and promote technological progress.

   The contribution of this paper is threefold. First, to the best of our knowledge, it is the first empirical research to examine long-run causality between energy transition and capital intensity for China. Second, this paper provides another insight on the mechanism of energy transition at the macroeconomic level. That is, as a historical phenomenon, energy transition in developing countries is associated with the capital deepening process of the nation and inherently determined by factor endowments at the aggregate level. Third, our findings suggest public policy is coordinating energy transition and economic growth by the principle of 'greening capital while greening energy'.

   The remainder of the paper is organized as follows. Section 2 summarises the relevant literature and describe a conceptual framework for the connection between biased technical change, capital intensity and energy transition. Data sources, variable definitions, time series constructions, and the stylized facts are presented in Section 3. Following, Section 4 presents the econometric model including unit-root test, Granger causality test, Johansen cointegration test, and VECM model. Results will be reported in Section 5. In the last section, we discuss policy implications and conclude.

2. RELATED LITERATURE AND CONCEPTUAL FRAMEWORK

   There is abundant evidence from the literature on how the production of different types of energy is connected to the capital intensity of the economy. For instance, in a pre-industrial country, energy products are relatively labor-intensive. A survey conducted in the 1990s shows that fuelwood accounted for more than 80% of fuel consumption by households in Bangladesh, Pakistan and Sri Lanka (Bhattarai 1997). Early settlers in the United States in the nineteenth century, poor rural populations in India and high mountain regions of China (Tibetan) collected bufalo dung for fuel (Smil 2010, 26). As new energy production technologies become available as industrialization occurs, the production of modern energy increases requiring more capital input relative to labor, due to capital becoming abundant and wages rising. At the same time, capital-intensive devices that make use of modern energy are more afordable to consumers in economies with higher capital intensity.

   Best (2017) investigated the relationship between capital cost and energy transition in the United States. Coal and natural gas electricity generators rank lowest in capital cost among all primary energy sources -coal, natural gas, hydroelectric, geothermal, nuclear, biomass, wind and solar. Solar energy has the highest capital cost, around 22,500 USD/kW, which is five times higher than coal, at 4,000 USD/kW. Although the study does not give the capital-labor ratio of energy directly, it provides insights into the capital requirements of different types of primary energy for electricity production. Hartley (2018) provides additional evidence.

   Antweiler, Copeland, and Taylor (2001) and Copeland and Taylor (2013) analyze the relationship between the pollution generated from dirty energy consumption and capital...