Economic growth, energy prices and technological innovation.

• Author: Gardner, Thomas A.

1. Introduction

   Energy economists are repeatedly asked to analyze the short run and long run macroeconomic effects of energy price shocks. We examine the effect of energy prices in a dynamic model of economic growth as a function of capital, labor, energy prices, and technological innovation. Our approach extends earlier studies in two ways. First, we depart from the standard approach of modeling strictly in either levels or differences by using an error correction model. The advantage of this approach is that both short run and long run information is used in the model. Second, we construct a measure of technological innovation with patent filings. Typically, deterministic trends have been used to capture technological growth. The increase in energy efficiency since 1974 has been due to energy conservation and improvements in energy intensive capital stock and production processes. We try to simultaneously use energy prices and technological innovation in a model of macroeconomic growth.

   If energy price symmetry is imposed, we conclude that the short run energy price effects are approximately half the long run energy price effects. When the restriction is relaxed short run price symmetry does not hold. In particular, short run price increases are associated with economic downturns while short run price declines have no significant impact on economic activity. Also, the results show that technological innovation, measured through the stock of patents, contributes both directly to economic growth and indirectly through improvements in the economy's capital stock.

   Section II briefly reviews empirical and theoretical research on energy and economic activity. The use of patents as measures of technological innovation and their relationship to macroeconomic growth are discussed in section III. In section IV we present a model of macroeconomic growth with technological change and empirical results are presented in section V. The conclusion follows.

2. Energy and Macroeconomic Growth

   The U.S. GDP to energy consumption ratio (billions of 1987$ to quadrillion BTUs) and the relative price of composite energy are plotted annually from 1949 to 1991 in Figure 1. (The data is described in Appendix A.) There are two distinct periods, pre- and post-1974. The efficiency of aggregate energy use rose in the first half of the 1950s, fell in 1955 and remained steady until 1966. At this point energy use increased relative to GDP until 1970, when it leveled off for three years. During the period 1949 to 1970 the relative energy price experienced no major fluctuations. Figure 2 contains plots of the level and growth rate of the relative energy price. Between the first oil price shock in late 1973 and 1982 the relative composite energy price increased 500%. Energy efficiency rose slowly; it took from 1974 to 1979, the second oil price shock, to reach the efficiency level of 1955. Since then aggregate energy efficiency has increased by 25%. The relative composite price started falling in 1983 with a major collapse of nearly 40% in 1986, the third oil price shock. Since then energy efficiency has remained steady.

   Douglas Bohi [2] conducted a comprehensive study of energy price shocks and macroeconomic performance. His approach employed a traditional static model of growth and cross-section data. He tested whether the three energy price shocks of 1973, 1979, and 1986 had an important effect on output and employment in the United States and other industrialized countries. He finds little support for the conventionally assumed importance of energy prices in explaining aggregate economic performance. He concludes that energy's share of GNP is too small to account for the large fluctuations in economic activity and that macroeconomic stabilization policies may shoulder the blame.

   John Tatom [28; 29; 30] tests the hypothesis that the effect of oil price declines are asymmetric to those of oil price increases. He begins by addressing the theory of economic effects of oil price shocks. He addresses the following issues (1) whether oil price shocks are transitory, (2) whether capital obsolescence is important, (3) whether adjustments are symmetric in response to price changes, and (4) role of domestic oil production.

   On the aggregate supply side, Tatom finds that following an oil price increase the resulting effects go beyond a simple increase in the cost of output, as standard theory predicts. In addition, the shocks alter the incentives to employ energy resources and alter the optimal methods of production. These incentives are reversed during an oil price decrease leading to a symmetric analysis. The basic outcome when energy prices rise is a higher price level, lower output, lower real wages, and, over time, a reduced capital stock relative to labor.

   He attacks the argument that firms react differently to an energy price cut than a price rise, because this view ignores maximizing behavior, a firm's self-interest in efficiency, and pressure from competitors. He states that at best any difference in a firms behavior is a matter of timing. In contrast, Hamilton [14] offers a theoretical rationale for asymmetric behavior in his paper on unemployment and the business cycle.

   Tatom claims that the argument asserting that the domestic oil industry impacts dominate other industries is overstated. This confusion arises as a result of the slow change in unemployment. The shock initially affects productivity and supply, which result in supply outracing demand changes. Thus, the inventory buildup/drawdown creates pressure on prices and cyclical pressure on unemployment.

   Timothy Considine [6] develops a neoclassical model to look at the impact of the 1986 collapse in energy prices on the macroeconomy. The economic performance following the 1986 price drop challenged three existing paradigms of energy price interactions.

   His first challenge was to the view that since world oil reserves are fixed and that as consumption rises oil prices will increase faster than overall inflation. Considine points out that real oil prices from 1859 to 1986 have resembled a random walk and argues the 1986 plunge was a correction to the price increases in 1979-1981.

   The second challenge was to the idea that lower oil prices are unambiguously "good" for the U. S. economy. Based on numerous accepted studies showing higher energy prices leading to higher inflation, lower output, and higher unemployment, symmetry would call for lower oil prices to generate economic "benefits". With the data from 1986 showing only minor benefits Considine asks whether other factors offset the presumably stimulative effects of lower oil prices or is the macroeconomic response asymmetric? He concludes that other factors, like the fall in output and the unemployment increase in the energy sector offset the assumed positive effects. In 1986 the combination of a 3 percent fall in domestic petroleum's production, a 4 percent decline in natural gas' production, and the increase in the trade deficit's reduced the macroeconomic response to the energy price drop.

   His third challenge is that large increases or decreases in energy prices impose adjustment costs on the economy. The common wisdom was that resource allocation may take time due to delays in obtaining information. As an example of informational delay laid off workers in the oil industry remained in the oil producing region(s) anticipating the layoff as a temporary downturn and expecting imminent rehiring. After the extended downturn and displacement, experienced workers were reluctant to return to the fields when the oil industry recovered, because they feared the upswing would be temporary. Similar bottlenecks were observed in investment resources. Considine classifies adjustments as either consumer spending, producer decisions, or wage and price adjustment and notes that these adjustments are intertwined with monetary and fiscal policies. He concludes that for offsetting reasons the adjustment costs are low.

   Hamilton [15] finds that oil price "shocks" proceeded seven of the eight post World War II recessions by about three-quarters of a year. (If data through 1991 is added the record runs to eight of nine recessions.) He finds that the oil price shocks are best interpreted as events exogenous to the U.S. economy...