The supply of electricity is a necessary ingredient for economic and social development in low income countries. Electricity is considered to be one of the most important services for improving the welfare of individual citizens. In the digital age, it is difficult to visualize development without electricity. Apart from the availability of energy per se, change in the quality of energy is one of the most important drivers of productivity.
The process of economic development necessarily involves a transition from low levels of energy consumption to higher levels where the linkages between energy, non-energy inputs and economic activity change significantly as an economy meanders through different stages of development. With such progress, commercial fossil fuels and ultimately electricity becomes predominant. Further, the expansion of electricity supply is critical to minimize the consumption of biomass fuel that has been responsible for the massive deforestation, desertification and many health problems.
All of the above sounds fairly straightforward and non-controversial, right? Not really. Count on economists for coming up with Harry Truman’s proverbial “on the other hand”. In other words, there are no straight answers as is most often the case in the infernal complexities, contradictions and ambiguities of our favorite ‘dismal science’.
The direction of causality between electricity and economic growth remains unresolved among empirical economists. Central to the debate is whether electricity stimulates, is neutral to, or even hinders (if electricity is produced with dirty primary energy) economic growth. Some argue that use of modern energy complements labor and capital in the production process, thus alleviating a limiting factor to economic growth and technological progress. Proponents of this hypothesis believe that electricity has been a major source of increase in the standard of living as well as technological and scientific advancement of presently developed countries. Even in poor countries, use of electricity is associated with improving the health and educational standards. Others, however, contend that the role of energy is minimal or is neutral to economic growth. This is because the cost of energy is small as a proportion of GDP and thus energy use is not likely to have a significant impact on economic growth. Moreover, as the economy grows, its production structure shifts towards the less energy intensive service sector.
These contrasting hypotheses have motivated many researchers to explore empirically the direction of causality between electricity use and economic development. The evidence is mixed, with causality ranging from uni- to bi-directional. This conflicting evidence has major implications for energy policy. Unidirectional causality running from electricity to economic growth implies that fall in electricity use could lead to a decline in economic growth. In contrast, uni-directional causality running from economic growth to electricity imply that shortfall in the availability of electricity consumption may have no adverse effect on economic growth. If there is no causality running in any direction, availability of electricity consumption cannot be a binding constraint on economic growth. In contrast, if there is a two-way causality, economic growth may demand more electricity while more electricity use may induce economic growth. In this case, electricity consumption and economic growth complement each other and electricity shortage will constrain economic growth.
There is one set of general conclusions that appear fairly robust. Wealthy countries have a stronger correlation between electricity use and wealth creation than do poor countries and, for the global economy as a whole, there is a stronger correlation between electricity use and wealth creation than there is between total energy use and wealth. Studies show that, in rich countries, the increase in wealth over time correlates with an increase in the electricity/Energy ratio. With economic development comes inter-fuel substitution from conventional fuel like coal, firewood and oil to electricity in various sectors. Because of their higher disposable income, households become more and more dependent on the electric appliances and gadgets for comfort and recreation. The industrial and commercial sectors, where electricity is used as basic energy input because of its cost efficiency, expand. Electricity consumption in agricultural and transport sectors also accelerate to keep pace with economic growth.
Work done at the Global Energy Network Institute shows that increasing electricity consumption per capita can enhance social development and economic growth. They look at a group of 19 medium and low human development countries and find that the threshold for moving from a low to medium human development economy (based on UNDP’s Human Development Index) appears to be when 500kWh per capita consumption of electricity is attained. In South Asia, only India has surpassed this threshold and that too barely with 542kWh per capita electricity consumption in 2007. About 25 countries, including Bangladesh (144 kWh), are below this threshold. For these countries that are starving for electricity, the debate on the direction of causation is academic, for they are suffering the consequences of a simultaneous relationship that has turned vicious—electricity supply has failed to keep pace with demand growth leading to rapid increase in power outages and load shedding which, in turn, is choking growth.
Management of energy supply is the fundamental problem many developing countries are currently facing. A sound energy policy is needed to solve the twin problems of low access and inadequate financial resources. Without making the environment conducive to attracting the huge financing needed to meet the energy shortage, these countries will have to do without modern electricity for years to come. Unless the physical and institutional infrastructure necessary for supply of electricity and other forms of energy is firmly in place, the talk about making electricity a driving force in economic development will remain loose at best. The average person in a typical low income country still uses less energy than the average person in England more than a century ago.
Worrying about causality in empirical research is a right thing to do. However, in drawing policy lessons from such research, the practitioners ought to make sure that scientific precision does not become the enemy of common sense.