Recessions, creative destruction and the shift to a greener energy mix

0

Pragyan Deb, Davide Furceri, Jonathan D. Ostry, Nour Tawk January 31, 2022

The COVID-19 recession has reduced overall energy demand, but electricity generation from renewable sources has increased and held up. Based on data from a panel of 176 countries over the period 1965 to 2019, this column shows that recessions lead to a permanent, albeit small, increase in energy efficiency and the share of renewables in electricity total. These effects are stronger when complemented by environmental and energy policies to incentivize and accelerate the transition to renewable energy sources.

Lockdowns resulting from the COVID-19 pandemic have reduced overall energy demand in 2020. However, electricity generation from renewable sources has been surprisingly resilient and, as a result, the share of renewables in energy demand electricity has increased in many regions (International Energy Agency 2020). What remains an open question is whether recessions themselves tend to spur investment in more efficient and greener energy sources, or instead continue to invest in old coal-fired power plants. On the one hand, the disruption of funding caused by the crisis can reduce innovation through a decline in research and development, which is very procyclical (De Haas et al. 2021). On the other hand, declining energy demand and associated factory shutdowns caused by the recession may offer energy producers the opportunity to improve their efficiency by replacing old, environmentally unfriendly factories with renewable energy sources when demand picks up. The idea that obsolete units are destroyed and replaced by newer technological innovations dates back to Joseph A. Schumpeter’s thesis on “creative destruction” (Schumpeter 1939, 1942), economic disruptions such as that caused by the pandemic acting as a cleaning period (Caballero and Hammour 1994).

Impact of recessions on consumption and the energy mix

We go to the data to answer this question in our new research (Deb et al. 2021). Specifically, we study the response of the share of renewables in total energy to major historical recessions (including financial crises and pandemics) for a panel of 176 countries over the period 1965 to 2019, using the methods of local projection proposed by Jordà (2005) .

The results suggest that recessions are associated with a significant drop in energy consumption. Although the initial decline corresponds to the decline in production, with no statistically significant change in energy intensity, over time, as production recovers, energy consumption increases at a slower rate than production and is permanently lower compared to a reference situation without recession. As a result, energy intensity decreases in the medium term.

Beyond that, the energy mix becomes greener after a recession, with the share of electricity generated from coal decreasing by around 1% after five years, while the share of renewables increases by almost 2% (figure 1). In other words, we find that recessions – such as those associated with the COVID-19 pandemic – tend to accelerate underlying trends towards renewable energy.

Figure 1 Evolution of the energy mix after the recession (change in share, %)

Source: Deb et al. (2021)
To note: The impulse response functions are estimated from a sample of 172 countries over the period 1985-2019. The graph shows the response and the 95% and 90% confidence bands. The horizontal axis shows the years after the event, t=0 being the year of the recession.

Role of environmental policies

Policy can be a powerful tool to accelerate the transition to a greener energy mix after recessions (OECD 2010, Persaud 2021). Bowen and Stern (2010) argue that recessions offer a “very good opportunity to undertake a necessary step change in the public expenditure component of environmental policies and to begin to fill a backlog of public investments to improve the environment”. Environmental protection schemes (EPS) can stimulate the transition to renewable energy, with high EPS associated with an increase in the share of renewables in total electricity after a recession, while the effect does not is not statistically significant in low EPS diets (Figure 2). While on average a recession is associated with a two percentage point increase in the share of renewables, countries with high EPS see a much larger increase – almost double to around four percentage points. Market-based EPRs – such as pollutant taxes, trading schemes such as carbon trading, energy saving and green energy certificates, and feed-in tariffs for renewables – are the most effective in accelerating the transition to a greener energy mix. Non-market-based BEPs – such as emissions and fuel standards and R&D incentives – are also associated with an increase in the share of renewables after a recession.

Figure 2 Impact of environmental protection regimes

Source: Deb et al. (2021)
To note: The bars show the impact of growth slowdowns after five years on the energy mix estimated from a sample of 33 countries over the period 1990-2015. We use a soft-transition autoregressive model to formally assess the impact of environmental protection programs (EPS) on the energy mix after a recession, with the red bars showing the impact at high EPS regimes while the gray bar shows impact at low EPS rpm. .

Recessions, such as the current one, provide a window of opportunity to achieve a more resilient and greener recovery (Georgieva 2020), not least because of the creative destruction that often accompanies downturns. Although climate change and clean energy policies can generate opposition from energy-consuming industries and the general public, and therefore incur electoral costs for incumbent politicians, these costs can be avoided if the design mitigation policies takes into account political economy dimensions and whether complementary policies are deployed to protect vulnerable households (Furceri et al. 2021).

Note: Opinions expressed in this column should not be attributed to the institutions with which the authors are affiliated.

The references

Bowen, A and N Stern (2010) “Environmental Policy and the Economic Downturn”, Oxford Review of Economic Policy 26(2):137-163.

Caballero, RJ and ML Hammour (1994), “The cleansing effect of recessions”, American Economic Review 84(5): 1350-1368.

De Haas, R, R Martin, M Muuls and H Schweiger (2021), “Barriers to net zero: How enterprises can make or break the green transition”, VoxEU.org, 19 March.

Deb, P, D Furceri, J Ostry and N Tawk (2021), “Creative destruction during crises: An opportunity for a cleaner energy mix”, CEPR Working Paper 16819.

Furceri, D, M Ganslmeier and JD Ostry (2021), “Climate change policy design must internalize political realities”, VoxEU.org, 7 September.

Georgieva, K (2020), ‘The long climb: overcoming the crisis and building a more resilient economy’, speech delivered at the 125th anniversary of the London School of Economics, 6 October.

International Energy Agency (2020), Sustainable recovery, Special Report on World Energy Outlook, June.

Jordà, Ò (2005), “Estimation and inference of impulse responses by local projections”, American Economic Review 95(1):161-182.

Organization for Economic Co-operation and Development and M Ash (2010), “Taxation, Innovation and the Environment”, OECD.

Persaud, A (2021), “Three changes to the renewable energy regulatory framework to help save humanity’s future”, VoxEU.org, 23 February.

Schumpeter, JA (1939), Economic cycles: a theoretical, historical and statistical analysis of the capitalist process, McGraw Hill.

Schumpeter, JA (1942), Capitalism, socialism and democracy, New York: Harper, reissued 1975.

Share.

About Author

Comments are closed.