Energy Consumption and Trade Openness in the ...

Bulletin of EnergyEconomics

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Energy Consumption and Trade Openness in the Correction of GHG Levels in Spain Daniel Balsalobre-Lorente a, , Muhammad Shahbaz b a b

Department of Political Economy and Public Finance, University of Castilla-La Mancha, Spain Management Sciences, COMSATS Institute of Information Technology, Lahore, Pakistan.

Abstract This study tries to prove if applying environmental innovations in renewable energy sector has effects beyond the environmental correction process. An elaborated empirical model applies to Spanish economy to analyze not only the relationship between economic growth and environmental pollution but also effects of energy consumption, energy innovation and trade openness. This study confirms that renewable energy sources help correct per capita greenhouse gas emissions (GHGpc). The results are also consistent with our hypothesis about a positive impact of research development and demonstration (RD&D) measures in renewable sector, as well as measures supporting the replacement of fossil energy sources, have for strategies that seek to reduce air pollution levels. Otherwise this paper incorporates an interaction effect that measures the dampening impact of energy replacement and income over greenhouse gas emissions. To validate this hypothesis, this paper employsan estimation by Ordinary Least Square (OLS) in order to validate the existence of the Environmental Kuznets Curve for Spain between 1995 and 2012. Keywords: Energy, Trade, Environmental Kuznets Curve JEL Classification: Q41, Q55, Q56, 032 I. Introduction According to the worldwide scientific community [1], [2], [3], environmental destruction could lead to the loss of welfare, on global and structural scales. Many studies have discussed that greenhouse gas emissions contribute to warming global temperatures and associated climatic instability [2], [3], [4]. In recent years, the Spanish’selectricsector has simultaneously managed a process of liberalization which it has changed the energetic sector in Spain. The progressive replacement of conventional energy sources by renewable sources, has strained a dual objective; first to reduce the energy dependence and secondly the correction of environmental pollution process. These regulation measures are connected with the global problem of high GHG emission levels [5], [6]. ForSpain the energy policy regulations have been associated with a wide battery of regulations appeared under the general principles adopted by European Union [5], [6]. This regulation process has clearly biased its tactics towards the promotion of renewable sources, since the objective set by the EU for Spain [7], [8], [9]. Therefore, the strategy of the Spanish renewable energy policy, focused in the replacement of fossil sources, is evident and it has given rise to an unusual composition of the costs included in the electric tariff, which has aggravated the energetic problem in Spain1. So, the impact of renewable energy policy means that the system as a whole is having costs that more than double those of generation and which are progressively becoming more and more visible to final demand for electricity [10]2. This study tries to identify characteristic features of existing renewable energy promotion, innovation and trade openness, and their impacts on the reduction of per capita greenhouse gas emissions (GHGpc). Therefore, it includes an interaction variable which reflects the relevance of income levels over energy mix and how it affects to environmental correction process. This study employs the EKC model as empirical tool thought an OLS econometric model for Spanish economy (Figure-1). Finally, as indicator of wealthy of Spanish economy this model incorporates the effect of trade openness over GHGpc levels. These efforts have become priorities for many countries in the past decade [5], [12]; where environmental corrections requires a public intervention that seeks to improve both the environment and the economy.

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Corresponding Author Email: [email protected] In Spain, the society have assumed an extra cost under a scenario of economic recession, where financial annuity corresponding to the enormous accumulated debt of U$30.000 M. at the end of 2012. 2 In Spain, the 45.6% of electricity bill corresponds to the consumption of electricity, while the rest must cover the premiums for renewable energies (22.5%), VAT (18.7%), annuities paid as a result of the accumulated tariff deficit of previous years (6.1%), off-peninsular compensation (3%), and various concepts, including the nuclear moratorium [11]. 1

- 311 Citation:Balsalobre-Lorente, D. and Shahbaz, M. (2016). Energy Consumption and Trade Openness in the Correction of GHG Levels in Spain.Bulletin of Energy Economics, 4(4), 310-322.

Balsalobre-Lorente and Shahbaz / Bulletin of Enery Economics , 4( 4), 310-322.

Figure-1.Evolution of GHGpc and GDPpc (1995-2012) 35000.000

12.000

33000.000 10.000

31000.000 29000.000

8.000

27000.000 25000.000

6.000

23000.000 4.000

21000.000 19000.000

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17000.000 15000.000

0.000

GDP_PC

GHG_PC

Notes: GDP_PC (M.KteCO2)primary axis; GHG_PC(U$D) secondary axis.Source: [12] II. Literature Review The relationship between income and economic inequality, which was ﬁrst stated by [13], has been reinterpreted in an environmental economics literature since 1990s, under the name of Environmental Kuznets Curve (EKC). This study focuses on an analysis of the EKC and seeks to enrich existing literature by incorporating auxiliary variables associated with environmental regulation measures. Our study points out the positive effects of renewable innovation improvements on environmental quality. In the past, many studies that analyze the relationship between economic growth and environmental destruction, according to the EKC’s analytic scheme, propose a relationship between economic growth and environmental quality [14], [15], [16]. [14] contrast environmental destruction against economic growth. This nexus implies that environmental destruction is an increasing function of the level of economic activity, until it reaches a critical level, when higher income levels lead to improved environmental quality, in the shape of an inverted-U shaped [14], [17]. The EKC refers to the hypothesis that the relationship between environmental quality and per capita income expose an inverted U-shaped. Such analyses incorporate the efforts to replace conventional energy sources with renewable ones. The EKC hypothesis reveals that the economic growth could be compatible with environmental improvements, the main motivation is to search the evidence of a relationship between income and environmental degradation, so if the answer is that economic growth can be a part of the solution for environmental problems. [14] provides a methodical explanation for the relation between environment and income. They argue that economic growth affects the environment in three different channels: scale, composition, and technique effect (Figure-2). Figure-2 shows the scale effect that asserts that even if the structure of the economy and technology, of the countries, does not change, an increase in production will result in decreased environmental quality. Consequently, the economic growth through scale effect has a negative impact on the environment correction process. On the other hand economic increases in development stretch the chance of investing in clean industry and services as well as improving production techniques (composition and technique effect). The composition effect, through the change in the production structure, reduces the damaging effects of economic growth on the environment pollution [18]. Finally, the technique effect captures improvements in productivity and adaptation of cleaner technologies, which will lead to an increase in environmental quality. This effect suggests improvements in technology willreplace the obsolescence in the production of goods. Consequently, when both the composition and the technique effect overcome the scale effect and it generates a downward trend of the EKC curve [19], [20]. Following [21], the economic activity will correct the level of environmental contamination, mainly through innovation. In addition, some studies highlight the positive effect of technology and structural changes over GHGpc emissions over time [18], [22], [23], [24], [25], [26], [27] and [28]. Therefore this perspective links the EKC with technological development.

- 311 Citation:Balsalobre-Lorente, D. and Shahbaz, M. (2016). Energy Consumption and Trade Openness in the Correction of GHG Levels in Spain.Bulletin of Energy Economics, 4(4), 310-322.


Figure-2. Inverted U-shaped in the Environmental Kuznets Curve: Scale, composition and technique effect

Source: Prepared by the authors. In addition, the EKC hypothesis suggests thatregulation processes in technological innovation offer an additional explanation, backed by the endogenous theory, where the income level/environment nexus is due to the improvement in the production process thanks to technological change [29]. Focusing on the EKC interpretation proposed by [30], the decontamination processes depend mainly on technological factors, where the processes of technological innovation make environmental correction possible [31], [32]. To achieve this objective there are necessary reforms and institutional changes [27], [33], [34], and [35]. Therefore, energy regulation entails measures that contribute to both energy savings and efficiency [36]. Consequently, when society implementsenergy regulation measures itconditions the income-environment relationship and more efficient processes takes place [29], [37], [38], [39] and [40]. To this end, it is necessary to examine an additional variable, namely, the share of renewable energy consumption, in order to estimate the relationship between economic growth and renewable energy consumption [41], [42]. So, our main hypothesis considers that both the renewable energy RD&D and the promotion of renewable sources contribute positively to environmental correction, on a path of sustainable economic growth. This study also examines the role of energy consumption is essential in the evolution of GHG emissions levels. Some studies show the positive impact that energy consumption has on increases in GHG emission levels [42], [43] and [44]. In other words, energy demand is linked to economic growth, and this connection affects air pollution levels. Many studies consider energy consumption in the context of four growth hypotheses (growth, conservation, feedback and neutrality) that support the idea of interdependence between energy consumption and economic growth [45] and [46] among others3. In Addition, efforts in the promotion of renewable energy consumption seeks to signify energy replacement, due to the impact that renewable sources have on energy consumption. By including these variables in assessing the relationship between income level and contamination, the main hypothesis of this paper is to demonstrate a positive role that both the promotion and innovation in renewable sources exerts over GHGpc levels. Usually, the promotion of renewable energy sources has been used as an alternative to conventional energy production systems. Nowadays, annexed to the current energy model, it is necessary to take into account the constraints associated with the degree to which a society can assume the internalization of emissions costs [10], [59] and [60]. In other words, this perspective implies that any environmental regulation implies an initial overcost that must be borne by society as a whole [61]. Otherwise, when policy makers integrate corrective measures based on the promotion of renewable energies, it is expected thatthese measures willbe competitive and efficient in the long-term[62], [63]. Under this environmental framework, dynamic 3

The growth hypothesis proposes that energy consumption is an important complement in the process of economic growth, based on the unidirectional causality running from energy consumption to economic growth [47], [48], [49], and [50]. The conservation hypothesis supports the existence of unidirectional causality running from economic growth to energy consumption [51], [52] and [53].The feedback hypothesis considers a bidirectional causality between energy consumption and economic growth [54], [55], [56] and [57]. The neutrality hypothesis provides for causality between economic consumption and economic growth, whereby reducing energy consumption does not adversely affect economic growth [58]. - 312 Citation:Balsalobre-Lorente, D. and Shahbaz, M. (2016). Energy Consumption and Trade Openness in the Correction of GHG Levels in Spain.Bulletin of Energy Economics, 4(4), 310-322.


efficiency would be determined by the technological processes derived from compliance with environmental regulations, where regulatory policies acquire special relevance, both in pollution reduction processes and in the development of innovations capable of reducing costs of energy generation. Therefore, it is necessary to create incentives for long-term through the promotion of renewable energy sources, although it is certainly not easy to infer controversial results. So, the public intervention aimed at correcting these deviations successfully will improve net social welfare as long as the costs incurred can be absorbed by the welfare gains obtained [64]. By extension, our study supposes that the energy sector in Spain operates under an imperfect competition model, which it is compatible with the existence of financing activities that generates technological progress [64]. So, following Gradus and Smulders [29], it is expected a direct relationship between energy improvements and corrections of environmental pollution levels. Otherwise, this study incorporates an additional explanation based on the connection between renewable output (RNW), economic growth (GDPpc) and environmental pollution (GHGpc). This study considers the existence of a positive relationship between renewable output and income that helps to control environmental pollution levels (Figure-3). To validate this hypothesis, we considered that economic growth interacts positively with renewable energy output and this interaction reduces GHGpc emission levels. Figure-3 shows the existence of an interactioneffect (between economic growth and renewable energy output) over GHG pc levels. Figure-3. Interaction effect between renewable output, GDPpc and GHGpc

Notes: Figure-2 contains path diagrams [66] for the situation that incorporates a third variable. The interaction variable alters the magnitude and/or direction of the relationship between the independent variable and the response variable, by amplifying or even inverting their causal effect. It usually reflects a stable, behavioral or contextual characteristic. Source : Prepared by authors Finally, this study reflects the existence of a relationship between trade openness and environmental pollution levels [67], [68], [69], [70], [71], [72], and [73]. Some studies reveal that trade openness increases environmental pollution levels [70], [71], [72] and [73]. The existence of a direct relationship between trade openness and environmental degradation process implies the existence of a transition from developing to developed stage of economic growth; where scale effect infers over trade liberalization [70], [71]. On the other hand, this relationships changes when composition and technique effects the scale effect. This process occurs when changes the industrial structure and it boosts economies to use more efficient and cleaner technologies. So, the net effect of trade openness will depend mainly on which effect exerts a higher impact over economic system [44], [70], and [74]. III. Empirical Model To demonstrates our main hypotheses (direct relationship between the promotion of renewable sources and the environmental correction process), this study develops some of the most important aspects of the EKC theoretical model. Since [14], many studies have considered the link between economic growth and environmental destruction though an inverted U-shaped relationship [17], [22], [35] and [75], among others. - 313 Citation:Balsalobre-Lorente, D. and Shahbaz, M. (2016). Energy Consumption and Trade Openness in the Correction of GHG Levels in Spain.Bulletin of Energy Economics, 4(4), 310-322.


This empirical study considers the general theoretical framework (Equation-1) which it identifies the existence of different relationships between environmental destruction and levels of income: GHGpcit = αit+ β1GDPpcit+ β2GDPpc2it+ β3Zit + eit,

(1)

GHGpcit refers to pollution or environmental destruction, GDPpcit is the level of income per inhabitant, and Zit indicates other influences on environmental pressure. From Equation-1, depending on the value allocated to coefficient β1 and β2, the EKC can adopt different forms4. Figure-2 shows how an economy that reaches a certain level of income (highest point) also experiences decreases environmental pollution with continued growth in the level of income. The U-inverted relationship has also been well discussed in the literature of EKC, where environmental degradation initially increases with the level of per capita income, reaches a turning point, and then declines with further increases in per capita income are consistent with EKC hypothesis [14], [17], [18] and [22]. This behaviours considers that economies might reach a path of increasing contamination due to a scale effect that overcomes the composition and technology effects when the margin for continuous improvement in distribution gets exhausted or when the diminishing returns on technological change reduce contamination through technology depletion. This point of view raises the possibility that, once the technology improvement cannot go further or becomes too expensive, net environmental degradation results from increased incomes [76]. Therefore, an adequate environment regulation policy could effectively accelerate technology changes capable of decreasing the level of contamination [31], [32], where many studies have demonstrated that changes in the energy-mix pattern and the promotion of renewable energy sources have a direct impact on the reduction of GHG emission levels [60], [77]. Equation-2 presents the main model of this study, where we employ an extension of Equation-1 where there are included other additional variables, using Ordinary Least Square (OLS) model for Spain during 19952012: GHGpc = α + β GDPpc + β GDPpc + β EC + β RNW +β GDPpc ∗ RNW + β TO + β RDD_RNW + ε (2)  GHGpct = GHG emission levels, measured in millions of tonnes CO2, per capita in Spain in year t [12].  GDPpct = Income level, GHG per capita measured in millions of U$ dollars, at current prices and current PPPs, for Spain in year t [12].  ECt= Energy consumption, measured in Gw/h for Spain in year t [12].  RNWt = Renewable energy output, measured in Gw/h, for Spain in year t [12].  GDPpct* RNWt = The product of GDPpct and RNWt. The coefficient β5accompanying this variable measures the interaction effect that variable GDPpcit provokes has on the causal effect of the independent or exogenous variable, RNWit, and the dependent or endogenous variable, GHGpcit. This interaction reflects the theoretical assumptions of the EKC model. If a seemingly causal relationship can be established between the independent variable RNWt and a response variable GHGpcit, we also must consider the potential role of other variables, such as GDPpcit in our case.  Tot = Free trade, as a proxy of trade openness. [78]  RDD_RNWt = Public budget in renewable energy in millions of US dollars, for Spain in year t [12]. Otherwise, to check the paper that playsthe public budget in renewable energy RD&D, carried out for every country as a measure of technological innovation, we are going to compare the Equation-2 to the Equation3, being able to see this effect by omitting the renewable innovation measuresin this last equation. GHGpc = α + β GDPpc + β GDPpc + β EC + β RNW +β GDPpc ∗ RNW + β TO + ε (3) Finally Equation-4 will confirm the existence of an U-inverted relationship between income and environmental degradation for Spain between 1995 and 2012: GHGpc = α + β GDPpc + β GDPpc + ε (4)

4

If β1> 0, β2 < 0, reveals the existence of an U-inverted relationship between income and environmental pollution levels (Figure-2). - 314 Citation:Balsalobre-Lorente, D. and Shahbaz, M. (2016). Energy Consumption and Trade Openness in the Correction of GHG Levels in Spain.Bulletin of Energy Economics, 4(4), 310-322.


All these models (Equations 2, 3 and 4) were using Ordinary Least Squares (OLS). The estimated models were then exposed to diagnostic tests for serial autocorrelation and heteroskedasticity of errors and stationarity of variables. Across all models and time periods the goal of the model estimation process is to determine the existence of an EKC for GHGpcit emissions in Spain. Positive coefficients on the GDPpcit variable and negative coefficients on the GDPpct2variable would indicate an upsidedown U-shaped curve relationship for GHGpcit emissions and GDPpcit (Figure-3). IV. Results And Discussion We first estimate Equation-2 with fixed effects for the cross-sections using ordinary Least Square (OLS) method and correcting for heteroscedasticity in the cross-section. We provide the results in Table-1. Table-1. Estimation Result (Equations 2,3 and 4) Depend. Variable: GHGpc const

GDPpc

GDPpc2

EC

RNW

GDPpc*RNW

TO

RDD_RNW

R-square F(6, 11) P value (F) Durbin-Watson Whiteheteroskedasticity Chi (2) LM AR(1) Harvey-Collier

Model 1(Equation 2) -5.48894 [-1.3522] (0.1763) 0.000238089 [2.1551] (0.0312)** -5.40298e-09 [-2.3410] (0.0192)** 7.36691e-05 [9.5031] (