Recent Evidence for Large Rebound: Elucidating the Drivers and their Implications for Climate Change Models.

• Author: Saunders, Harry D.
• Position: Report

INTRODUCTION

Recent work by Stern and Kander (2012), Fouquet (2012), Fouquet and Pearson (2012), and Tsao et al. (2012) has provided the energy economics community with important new findings concerning the evolution of energy demand over time horizons spanning centuries. These results have rather profound implications for climate change mitigation policy and the current models supporting it.

Their results enable far deeper insights into the connections among energy use, economic growth, prices, technology gains, and energy efficiency rebound effects than heretofore have been possible. The Fouquet, Fouquet and Pearson, and Tsao et al. articles provide new insights viewed from the vantage of the end-use energy consumption side of the equation; the Stern and Kander article (and also the Tsao et al. article) provides deeper insights as viewed from the production side.

This article uses these results to extract new insights that bear on the design and implementation of models used for energy consumption forecasting, highlighting the drivers that matter most and assumptions that need to be given the closest scrutiny.

The article structure is as follows: The next section reprises the theoretical underpinnings, and their history, that later will provide useful points of reference for understanding the arguments developed. The section following describes the recent results from a consumption-side perspective. The subsequent section takes a deeper dive into the Stern and Kander results and elucidates the production-side mechanisms at work. Then, the implications for climate change mitigation policy are summarized. Following that is a critique, based on the insights gained, of the models currently in use for informing climate change policy. The article concludes with consequent suggestions on the path forward for energy economists.

1. THEORETICAL UNDERPINNINGS

   Researchers aiming to explore the relationships between energy consumption and environmental sustainability have historically wrestled with multifaceted considerations that cross multiple economic domains. Adequately addressing the problem has required them to explore the complex connections among energy use, economic growth, prices, and technology gains. In light of this complexity and the need to confine the problem, research efforts seem to have fallen into two major categories. The first relates to energy end-use consumption--consumption of energy by consumers for household uses and for personal transportation. This is the realm that most energy users, and especially lay people, can directly relate to as it reflects what they can observe in their personal energy-use decision making. The second relates to the use of energy to produce and move goods and services, which likewise are ultimately consumed by households. These goods and services have "embedded" within them the energy used to produce and transport them to end users.

   To place this distinction in perspective, only about one-third of global energy consumption is end use energy consumption--energy consumed by households and for personal transportation. (1) This means two-thirds of all energy is consumed in production, in the creation and movement of goods and services. In the US, this "embedded" energy consumption is about 60% of all energy use, and this proportion has grown between 1987 and 2002. (2)

   The theoretical underpinnings of this problem by fortunate happenstance prove to be amenable to this very categorization, which is employed in the following descriptive narrative.

   1.1 The Consumption-side Perspective: Energy-Economic Growth Connections

   From the consumption side, the connections among energy use, economic growth, prices, technology gains, and energy efficiency rebound effects are typically viewed as requiring for their analytic description the microeconomic tools of consumer behavior. Analysts have historically looked at this question by appealing to price and income elasticities deriving, in principle, from consumer utility functions. The Fouquet (2012) and Fouquet and Pearson (2012) analyses adopt this perspective. Their approach to connecting energy use to economic activity is to relate energy use to income levels via income elasticity measurements--the image is that consumers use more energy the greater is their income, although not necessarily on a one-for-one basis, depending on the income elasticity.

   1.2 The Consumption-side Perspective: Rebound

   From the consumption-side perspective, rebound arises from energy efficiency gains decreasing the cost of energy services, causing increases in the consumption of energy services and thus the consumption of the physical energy required to provide these services. Price elasticities are invoked to measure these effects, and rebound magnitudes are equated to price elasticity magnitudes. If a 1 percent increase in energy efficiency leads to a 1 percent decrease in the cost of energy services, the argument goes, and if the price elasticity of energy services is, say, -0.6, consumption of energy services (and their associated physical energy use) will increase by 0.6%, revealing a rebound magnitude of 60%. This rebound magnitude is implicitly defined relative to a "zero rebound" condition where a 1 percent increase in energy efficiency would lead to a 1 percent decrease in energy services (and energy) consumption--that is, the expected situation were the technical engineering efficiency gains fully "take" and lead to a one-for-one reduction in energy use below where it would otherwise be.

   The Fouquet and Fouquet and Pearson results later described treat rebound in this manner.

   The fundamental insight here is that energy efficiency gains appear to the consumer as reductions in the price of energy services, and price elasticity considerations will thereby induce them to consume more energy services (and more of the physical energy attendant to producing them).

   There is a further rebound effect discussed in the literature that arises on the consumption side, the so-called "indirect" consumption effect (Greening et al., 2000; Sorrell, 2007; Turner, 2013). By reducing the cost of physical energy, energy efficiency gains cause consumers to have more disposable income that can be used for both increased energy consumption and increased consumption of other goods and services that have "embedded" in them the energy required to produce and move them. Not only is energy use thereby induced to increase, but these technical efficiency gains associated with the direct effect have also increased the disposable income of consumers. Such increases boost consumption overall and reflect an increase in consumer welfare that goes to growing economic activity (and the energy use associated therewith), although this effect is likely small and Fouquet and Fouquet and Pearson find no evidence for a causal connection that works in this direction for either lighting or transportation.

   So from a consumption-side perspective, the framework is that new energy efficiency technologies create effective price effects that are observable as energy price elasticities, that income elasticities reflect the connection to economic growth, and that rebound effects result from energy efficiency gains that reduce the price of energy services.

   1.3 The Production-side Perspective: Energy-Economic Growth Connections

   The production-side perspective goes back even further. The seminal contribution by Hogan and Manne (1977) showed the theoretical connections among energy price, economic output and GDP, and energy consumption in a comparative statics framework. These researchers were the first to make clear the central role of the substitution elasticity between energy and other input factors (hereinafter, the "energy elasticity of substitution") in linking energy availability to economic growth potential.

   Hogan and Manne used a nested CES-type production function to show that the reduction in economic output when energy input is reduced is extremely sensitive to the magnitude of the energy elasticity of substitution--when this elasticity is low, the reduction in economic output is large; when it is high, the reduction is smaller. These results show that the energy elasticity of substitution is a strong determinant of the linkage between energy availability and economic activity potential--the smaller the elasticity, the tighter the link.

   In their recent Energy Journal article, Stern and Kander (2012) have modified and extended the reach of these theoretical conclusions with a sophisticated empirical analysis, using 200 years of Swedish data. They employ a CES functional form with nesting like that of Hogan and Manne, but explicitly include (and measure) factor-augmenting technical change. They also introduce time dynamics by embedding this functional form within a Solow-style neoclassical growth model. These researchers show that the relationships among the energy elasticity of substitution, energy availability and economic growth are more complex when dynamics and multi-factor technology gains are considered, although the energy elasticity of substitution is still a key driver, as will be shown herein.

   1.4 The Production-side Perspective: Rebound

   While the energy elasticity of substitution is a primary determinant of the linkage between energy use and economic activity potential, this selfsame parameter also governs the magnitude of energy efficiency rebound effects.

   Another Energy Journal article (Saunders, 1992), using a functional form virtually identical to that of Stern and Kander and likewise embedded in a Solow-style growth model, established the link between the energy elasticity of substitution and the magnitude of rebound effects. It showed that the higher this substitution elasticity, the higher the rebound. A later paper (Saunders, 2008) formalized this connection for the particular functional form employed by Hogan & Manne and Stern & Kander. (3) Rebound R is defined...