Identification of how economic development affects energy use through a natural experiment

Abstract

ABSTRACT This paper empirically investigates how economic development (GDP) affects energy use. It deviates from previous studies in two important ways: (i) it explicitly allows the effect to be heterogeneous across regions, and (ii) it acknowledges that changes in GDP, i.e. GDP growth, can be endogenous and controls for this by exploiting deaths from natural disasters in 2002 and 2003. This instrument incorporates a natural experiment caused by the unusually severe heat wave that swept past several European countries in the summer of 2003. Based on data from 120 countries, results indicate that the marginal effect of the GDP rate is 66% higher when using 2SLS compared to OLS and that there is substantial heterogeneity across countries. Energy use is negatively correlated with the GDP level suggesting that there may be an Energy Kuznets Curve, but unexplained heterogeneity at high income levels suggests that there is still more to learn about the GDP-Energy relationship. HIGHLIGHTS Investigates empirically how GDP growth affects energy use. Utilises the 2003 European heat wave as an instrument for GDP. Results show the relationship is heterogeneous and OLS is downward biased. Indication of Kuznets effect, i.e. a stronger relationship for less developed countries.