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Energy Policy 32 (2004) 4754

Electricity consumption and economic growth in China


Alice Shiu*, Pun-Lee Lam
Department of Business Studies, The Hong Kong Polytechnic University, Room M805, Li ka Shing Tower, Hung Hom, Kowloon, Hong Kong

Abstract This paper applies the error-correction model to examine the causal relationship between electricity consumption and real GDP for China during 19712000. Our estimation results indicate that real GDP and electricity consumption for China are cointegrated and there is unidirectional Granger causality running from electricity consumption to real GDP but not vice versa. In order to overcome the constraints on electricity consumption, the Chinese government has to speed up the nation-wide interconnection of power networks, to upgrade urban and rural distribution grids, and to accelerate rural electrication. r 2002 Elsevier Ltd. All rights reserved.
Keywords: Electricity consumption; China; Error-correction model

1. Introduction In the past two decades, China has achieved rapid economic growth, and emerged as the second largest electricity consumer in the world, just behind the United States. Historically, the electric power industry was designated as a driving force of Chinas economic growth. In line with the rapid expansion of the Chinese economy after the late 1970s, there has been an increasing demand for electricity. In the past two decades, there has also been a growing interest in the study of the causal relationship between energy consumption and economic growth. However, it was surprising that so far there has been no empirical work on China. The purpose of this paper is to ll the gap in the empirical literature on the causal relationship between electricity and income, by studying the situation of China. At present, the Chinese government has a policy target of achieving a sustained growth rate of 7% per year. This implies that total output will be doubled every 10 years. The study of the causal relationship between electricity consumption and GDP will help us better understand the role of electricity in Chinas economic growth. The results of causality tests can shed light on future electricity policies, such as conservation pro*Corresponding author. Tel.: +852-2766-4016; fax: +852-27650611. E-mail address: bushiu@inet.polyu.edu.hk (A. Shiu). 0301-4215/04/$ - see front matter r 2002 Elsevier Ltd. All rights reserved. PII: S 0 3 0 1 - 4 2 1 5 ( 0 2 ) 0 0 2 5 0 - 1

grams, the planning of capacity expansion and the construction of nation-wide interconnection of power networks. Therefore, it is important to understand the relationship between electricity and income, should China want to avoid the electricity shortages that occasionally hampered its economic growth in the past. The study of the causal relationship between energy consumption and economic growth started with the seminal work of Kraft and Kraft (1978), in which causality was found to run from GNP to energy consumption in the United States. Empirical studies were later extended to cover other industrial countries like the United Kingdom, Germany, Italy, Canada, France, and Japan (Yu and Choi, 1985; Erol and Yu, 1987). In subsequent studies, instead of relying on the standard Granger causality test, the cointegration and error-correction models were applied to test for stationarity of the variables in the time-series. Moreover, some studies (e.g. Stern, 1993; Stern, 2000) tested for Granger causality in a multivariate setting by using a vector autoregression model. In recent years, empirical works on the causal relationship between energy consumption and economic growth have been focused on Asian economies. For example, Glasure and Lee (1997) have examined the causal relationship between energy consumption and GDP for South Korea and Singapore. The results of the cointegration and error-correction models indicate bidirectional causality for both countries. In contrast, Granger causality tests show a unidirectional

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48 A. Shiu, P.-L. Lam / Energy Policy 32 (2004) 4754

relationship running from energy to GDP for Singapore, but no causal relationship between energy and GDP for South Korea. The results for South Korea contrast with those of the Yu and Choi (1985) study, which showed unidirectional causality from GNP to energy consumption based on the standard Granger test. The results of studies for Taiwan, another newly industrialized economy, are also mixed. Cheng and Lai (1997) nd causality running from GDP to energy consumption without feedback, while Yang (2000) nds bidirectional causality in his study. Yangs result is consistent with the ndings of an earlier study done by Hwang and Gum (1992). He attributes the difference between his result and that of Cheng and Lai to the use of different sample periods, and the choice of different price indexes in measuring real GDP. Masih and Masih (1998) have applied Johansens multiple cointegration tests for the cointegration of the energy consumption, real income, and price levels of two less-developed Asian countries: Thailand and Sri Lanka. They nd that energy consumption is itself relatively exogenous, and conclude that it plays an important role in inuencing income and prices. Recently, Asafu-Adjaye (2000) has used cointegration and error-correction modeling techniques to estimate the causal relationships for India, Indonesia, the
Table 1 Empirical results from causality tests for Asian countries or economies Country India Empirical work Masih and Masih (1996) Asafu-Adjaye (2000) Ghosh (2002) Masih and Masih (1996) Asafu-Adjaye (2000) Erol and Yu (1987) Masih and Masih (1996) Masih and Masih (1996) Yu and Choi (1985) Masih and Masih (1996) Asafu-Adjaye (2000) Masih and Masih (1996) Glasure and Lee (1997) South Korea Yu and Choi (1985) Glasure and Lee (1997) Masih and Masih (1998) Hwang and Gum (1992) Cheng and Lai (1997) Yang (2000) Masih and Masih (1998) Asafu-Adjaye (2000)

Philippines, and Thailand. His results indicate a shortrun unidirectional Granger causality running from energy to GDP for India and Indonesia, but a bidirectional relationship for the other two countries. Asafu-Adjayes empirical results for Indonesia and the Philippines are different from other studies (Yu and Choi, 1985; Masih and Masih, 1996). Moreover, he includes energy prices in his study, and nds that energy, income, and prices are mutually causal for the Philippines and Thailand. For India and Indonesia, however, the causality is unidirectional, running from energy and prices to income. The results for India in Asafu-Adjayes study contrasts with those obtained from Ghosh (2002). Ghosh has applied Granger causality test on the bivariate vector autoregressive model (VAR) to test for causal relationship for India. Similar to our study, he focuses on a particular form of energy, i.e. electricity. The results indicate that there is unidirectional Granger causality running from economic growth to electricity consumption without any feedback effect. In Table 1, we summarize the empirical ndings of the causality tests between energy/electricity and income for a number of Asian economies. Despite the expanding literature on the study of causal relationships between energy and income for Asian economies, as mentioned at the beginning, there

Study period 19551990 19731995 19501997 19601990 19731995 19501982 1950-1973 19551990 19551990 19541976 19551991 19711995 19601990 19611990 19541976 19611990 19551991 19611990 19551993 19541997 19551991 19711995

Causal relationship (method used) Energy-income (error-correction) Energy-income (error-correction) Income-electricity (unrestricted VAR) Income-energy (error-correction) Energy2income (error-correction) Energy-income (standard Granger) Income-energy (standard Granger) Non-cointegrated (error-correction) Income2energy (error-correction) Energy-income (standard Granger) Non-cointegrated (error-correction) Energy2income (error-correction) Non-cointegrated (error-correction) Energy2income (error-correction) Energy-income (standard Granger) Income-energy (standard Granger) Energy2income (error-correction) No relationship (standard Granger) Energy-income (error-correction) Energy2income (Granger and Hsiao) Income-energy (Hsiaos Granger) Energy2income (error-correction) Energy-income (error-correction) Energy2income (error-correction)

Indonesia Japan Malaysia Pakistan Philippines

Singapore

Sri Lanka Taiwan

Thailand

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has been no empirical work on China, the great dragon in Asia. The purpose of this paper is to ll the gap by studying the causal relationship between electricity and income for China. In Section 2, we outline the background of the historical development of the electric power industry in China. Following this, Section 3 contains a discussion of the methodology and data used in our study. We report our empirical ndings in Section 4. Based on the ndings, we draw conclusion and provide policy implications of our causality study in the nal section.

2. Historical development of the electric power industry in China The electric power industry in China came into existence in 1882, with the establishment of the countrys rst generation plant in Shanghai. The industry has gone through slow expansion in early years, with most power generating units operating in small capacity with low thermal efciency. Since most of these power generating units were concentrated in a few big cities along the coastal regions, power supply in the interior provinces was limited. It was after 1949 that the Chinese government started to place greater emphasis on developing the power industry and the process has gone through different stages. The years from 1949 to 1951 were a period of rehabilitation and reconstruction. Major infrastructure facilities, such as electric power and transport systems, were revamped (Dorian, 1998). In late 1952, the government decided to undertake longterm economic planning, and adopted the Soviet model of development. During the rst and second ve-year plans (19531957 and 19581962), heavy industries were put in a strategic position. In order to facilitate the development of heavy industries, electricity prices were kept low. Great efforts were made to expand the electric power industry, and to build large generating equipment. As a result, the electricity elasticity, that is, the growth rate of electricity generation relative to the growth rate of real GDP, was generally greater than one. With the havoc caused by the Great Leap Forward in the late 1950s, the government realized that its strategies for accelerated growth in heavy industry were impracticable. The economy was then undergoing a period of recovery and readjustment (19611965). Then, the Cultural Revolution (19661976) started. Chinas coal industry was particularly hard hit by the political and social disturbances in the early years of the Cultural Revolution. In 1967, production of coal dropped by 18%, and did not recover to its previous level until 1969. The shortfall in coal supply had repercussions throughout other industries, particularly the electric power and iron and steel industries. Consequently, the

electric power industry did not expand as expected during the third and fourth ve-year plans (19661970 and 19711975). Power shortages continued throughout the 1970s, and this had an adverse effect on the outputs of other industries. After the death of Chairman Mao in 1976, the Chinese government introduced a 10-year economic plan. The plan was originally intended to cover the fth and sixth ve-year Plan periods (19761980 and 19811985), with the principal goals of recouping the economic losses suffered during the previous years of turmoil, and accelerating the growth of Chinas economy. The plan aimed to build up Chinas industrial capacity, and to enable the country to achieve an industrial ranking on a par with other advanced countries by the turn of the century. However, the plan later proved to be impracticable, and a three-year adjustment plan (19791981) came into effect. This adjustment also marked the emergence of a series of major economic, political, and social reforms. China adopted an open door policy in 1978, and the sixth ve-year plan was drafted in accordance with this policy. The Chinese government encouraged foreign capital, technology, and joint ventures that could assist the countrys modernization. The policy of opening up China to foreign countries continued into the seventh, eighth, and ninth ve-year plans (19861990, 19911995 and 19962000). Structural reforms, market incentives, and decentralization policies were introduced to attract foreign investment in the power sector and the sector started rapid growth since the late 1980s. Despite the remarkable growth in the electric power industry in the last few decades, the speed did not keep up to pace with the countrys economic growth. From historical data, it is found that there has been a decoupling of electricity consumption and economic growth in China, which means the rate of growth of electricity consumption is no longer a direct one-to-one correlation with the growth in GDP. In particular, after the adoption of the open door policy in 1978, Chinas power sector has not expanded as fast as the whole economy. The growth of capital investment in the power industry lagged behind economic growth. However, during the same period, demand for electricity in China increased tremendously, when the economy developed and the living standard of the people was improved. This results in a persistent supply-demand gap in the power sector. Apart from the capital constraint in the expansion of electricity supply, there are other possible reasons for the decoupling of electricity consumption and economic growth, such as improvement in energy efciency and energy conservation. We would consider the decoupling issue again in the last section, after reporting the empirical ndings of our study.

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3. Methodology and data According to Engle and Granger (1987), a linear combination of two or more non-stationary series (with the same order of integration) may be stationary. If such a stationary linear combination exists, the series are considered to be cointegrated and long run equilibrium relationships exist. Incorporating these cointegrated properties, an error-correction model (ECM) could be constructed to test for Granger causation of the series in at least one direction. In this paper, the ECM is specically adopted to examine the Granger causality between real GDP and electricity consumption in China. 3.1. Integration, stationarity and cointegration Since the use of the ECM requires the series to be cointegrated with the same order, it is essential to rst test the series for stationarity and cointegration. A series is said to be nonstationary (or stationary) if it has nonconstant (or constant) mean, variance, and autocovariance (at various lags) over time. If a nonstationary series has to be differenced d times to become stationary, then it is said to be integrated of order d: i.e. I(d).1 The augmented DickeyFuller (ADF) (Dickey and Fuller, 1979; Said and Dickey, 1984) and Phillips Perron (PP) (Phillips and Perron, 1988) tests have been applied for examining unit roots and stationarity in this paper. For both tests, we are testing the null hypothesis H0, that Yt is nonstationary, against H1, that Yt is stationary. When both series are integrated of the same order, we can proceed to test for the presence of cointegration. The Johansen maximum likelihood procedure (Johansen, 1988; Johansen and Juselius, 1990) is used for this purpose.2 Any long-run cointegrating relationship found between the series will contribute an additional errorcorrection term to the ECM. The Johansen procedure is a vector autoregressive (VAR) based test on restrictions imposed by cointegration in the unrestricted VAR. The null hypothesis in consideration is H0, that there are a different number of cointegration relations, against H1, that all series in the VAR are stationary. 3.2. Error-correction model The existence of cointegration relationships indicates that there are long-run relationships among the vari1 Note that a stationary time series has an integration order of 0, whereas a non-stationary time series has an integration order of 1 or greater. 2 In the presence of more than two series, the Johansen procedure has the advantage of allowing for the existence of multiple cointegrating relationships, and thereby the possible existence of dynamic interactions between two or more of the series in consideration.

ables, and thereby Granger causality among them in at least one direction. The ECM was introduced by Sargan (1964), and later popularized by Engle and Granger (1987). It is used for correcting disequilibrium and testing for long and short-run causality among cointegrated variables. The ECM used in this paper is specied as follows:3 X DYt a2 ay mt1 a21 iDYti X
i1 i1

a22 iDXti eyt; X


i1

DXt a1 ax mt1 X
i1

a11 iDYti 2

a12 iDXti ext;

where Yt and Xt represent natural logarithms of real GDP and electricity consumption, respectively, and (DYt, DXt) are the differences in these variables that capture their short-run disturbances. eyt ,ext are the serially uncorrelated error terms, and mt-1 is the errorcorrection term (ECT), which is derived from the longrun cointegration relationship i.e. Yt = b0 + b1Xt + mt and measures the magnitude of the past disequilibrium (it is called the ECT since the deviation from long-run equilibrium is corrected gradually through a series of partial short-run adjustments). In each equation, change in the endogenous variable is caused not only by their lags, but also by the previous periods disequilibrium in level, i.e. mt-1. Given such a specication, the presence of short and long-run causality could be tested. Consider Eq. (1), if the estimated coefcients on lagged values of electricity consumption are statistically signicant, then the implication is that the electricity consumption Granger causes real GDP in the short-run. On the other hand, long-run causality can be found by testing the signicance of the past disequilibrium term. 3.3. Data Our empirical study uses the time series data of real GDP and electricity consumption for the 19712000 period for China. Nominal GDP and electricity consumption data for China are obtained from the National Bureau of Statistics (19722001), Chinese Social Sciences Press (1987), Chinese Society of Electrical Engineering (1990), and China Electric Power Information Center (19952001). In this paper, electricity consumption is expressed in terms of billion kilowatt hours (kWh) or terawatt hours (TWh) and
3 Note that the ECM is a restricted VAR model that restricts the long-run behavior of the endogenous variables to converge to their cointegrating relationships while allowing a wide range of short-run dynamics.

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4500 Real GDP (billion yuan) Electricity Consumption (TWh) 4000 3500 3000 2500 2000 1500 1000 500 0 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1997 1999 1999 Real GDP Electricity Consumption

Year
Fig. 1. Real GDP and electricity consumption in China

0.8 Electricity Intensity (kWh/yuan) 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 Electricity / GDP

Year
Fig. 2. Electricity intensity in China

nominal GDP is deated by the GDP deator (using 1978 as the base year) to obtain the gure of real GDP in billion yuan. Fig. 1 is a graphical representation of the two series. As we can see in Fig. 2, electricity intensity in China (measured as an electricityGDP ratio) decreased from its peak of 0.69 in 1979 to as low as 0.48 in recent years.

4. Empirical results Table 2 reports the results of the ADF and PP tests on the integration properties of real GDP and electricity consumption for China. Results of the two tests indicate that the two series are found to be nonstationary. However, rst differences of these series lead to stationarity. These indicate that the integration of real GDP and electricity consumption for China is of order one, i.e. I(1).

Given that integration of the two series is of the same order, we continued to test whether the two series are cointegrated over the sample period. Table 3 shows the results of the Johansen test. The likelihood ratio (LR) test rejects the hypothesis of no cointegration, and indicates that there is one cointegrating equation at the 5% signicance level, i.e. there is a long-run relationship between real GDP and electricity consumption for China. The normalized cointegrating coefcients are shown in the last row of Table 3, and the signs of the variables conform to the theory in literature, i.e. there is positive relationship between electricity consumption and real GDP. Following the detection of the cointegrating relationship between real GDP and electricity consumption, an ECM was set up for investigating short and long-run causality. In the ECM, the rst difference of each endogenous variable (real GDP or electricity consumption) was regressed on a one period lag of the

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cointegrating equation and lagged rst differences of all the endogenous variables in the system. Table 4 shows the results of the tests on causality. We have performed several tests for Granger causality: (1) short-run causalitythe signicance of the sum of lagged

Table 2 Results of ADF and PP tests Variables Augmented DickeyFuller (ADF) Levels GDP Electricity Critical values 10% 0.72 0.39 2.60 First differences 2.63n 5.06n PhillipsPerron (PP) Levels 2.80 0.10 2.57 First differences 4.06n 5.06n

Note: The true data generating process for each variable has been found by following the procedures described in Enders, 1995 For the ADF tests, the appropriate lag lengths were selected using Akaikes Information Criteria (AIC) and a maximum of up to 4 lags has been incorporated due to limited sample size. For the PP tests, truncated lags are determined using the highest signicant lag (using approximate 95% condence interval) from either the autocorrelation function or the partial autocorrelation function of the rst differenced series. n Represents the rejection of the null hypothesis of nonstationarity at 10% level of signicance.

terms of each explanatory variable by joint F test; (2) long-run causalitythe signicance of the error-correction terms by t-test; and (3) short-run adjustment to reestablish long-run equilibriumthe joint signicance of the sum of lagged terms of each explanatory variable and the ECT by joint F test. Short-run causality is found only from electricity consumption to real GDP, but not the reverse, i.e. there is unidirectional Granger causality. The coefcient of the ECT is found to be signicant in the real GDP equation, which indicates that given any deviation of real GDP from the long-run equilibrium relationship ECT=GDPt-b0-b1Electricityt, both variables in the ECM would interact in a dynamic fashion to restore long-run equilibrium. Results of the signicance of interactive terms of change in electricity consumption (DElectricity), along with the ECT in the GDP equation are consistent with the presence of Granger-causality running from electricity consumption to real GDP. These indicate that whenever there is the presence of a shock to the system, electricity consumption would make short-run adjustments to re-establish long-run equilibrium.

5. Conclusions and policy implications This paper applies the ECM model to examine the causal relationship between electricity consumption and real GDP for China. Prior to testing for causality, the ADF test and Johansen maximum likelihood test were used to examine for unit roots and cointegration. Our estimation results indicate that there is a unidirectional relationship running from electricity consumption to real GDP, i.e. an increase in electricity consumption would raise real GDP but not the reverse. Our empirical ndings support the notion that there has been a decoupling of electricity consumption and economic growth. The rate of growth of electricity consumption is not a direct one-to-one correlation with GDP growth. The rapid growth in GDP might not trigger the similar

Table 3 Results for Johansen cointegration tests Variable Likelihood ratio 42.34 7.23 5% critical value 19.96 9.24 1% critical value 24.60 12.97 Number of cointegrating equation Nonennn At most 1

GDP Electricity

Normalized cointegrating equation: GDP=0.75+1.02 Electricity


nnn The rejection of the null hypothesis of no cointegrating equation at 1% level of signicance. The lag lengths were chosen by using AIC.

Table 4 Results of the error-correction model Source of causation Short-run DGDP Variable DGDP DElectricity F-statistics 0.94 9.76
nnn

ECT DElectricity mt1 t-statistics 6.85 0.91


nnn

Joint (short-run/ECT) DGDP,mt1 F-statistics 0.96 11.72nnn DElectricity, mt1

Note: mt1 represents the residual derived from normalizing the cointegrating vector on GDP. The optimal lag has been chosen based on AIC. Godfrey LM tests have been applied and results conrmed the absence of serial correlation in the ECM. nnn Denotes signicance at the 1% level.

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growth in electricity consumption. This direction of causation shed light on future electricity policies regarding environmental protection, generation, transmission and distribution. In the period under study, around 70%80% of the electricity consumption is for industrial production. Since industrial production contributes a large share of GDP, the growth in industrial demand for electricity increases industrial output and which, in turn, raises the real GDP of China. This implies that growth in electricity consumption causes real GDP growth via industrial demand for electricity. Given this situation, any shocks to electricity supply will adversely affect industrial output and thereby reducing real GDP growth. In order to avoid any adverse effect of electricity shortages on industrial production, it is important for the Chinese government to plan, and build enough generating capacity to satisfy industrial demand for electricity. These could be achieved through attracting new capital to the power industry. However, the economys reliance on coal for power generation will worsen environmental conditions. The governments long-term electricity policy should be focused on developing new sources of fuel, like natural gas, to replace low-quality coal, and on improving thermal efciency of power generation. Since China has the worlds largest unexploited hydropower potential, the government should continue her efforts to develop more hydropower reserves. Despite strong electricity consumption in the industrial sector, Chinas per capita consumption of electricity is still low (about one-third of the worlds average level). When the income and living standards of the population increase, demand for electricity will increase via the increasing demand for electrical appliances and other consumer durable goods. But at present a large number of rural population still have no access to electricity and some areas still face the problem of power shortages. Insufcient capital investment in power generation and transmission, higher tariffs and fees imposed on consumers in rural areas have deterred the natural growth of electricity consumption. Before the mid-1990s, frequent outages in electricity supply had adversely affected industrial production and electricity consumption. Therefore, it is not surprising to nd that rapid real GDP growth did not cause a corresponding increase in electricity consumption in China, as our results indicate. Apart from the problem of capital constraint on expanding electricity supply to the rural areas, the decoupling of electricity consumption and GDP growth can be a result of improvement in energy efciency. There is more and more evidence suggesting that the Chinese economy is more energy efcient today than a decade ago (China Electric Power Information Center,

2000; Hirschhausen and Andres, 2000; Sinton and Fridley, 2000). Contrary to other developing countries, both the energy intensity and electricity intensity in China have been below unity over the last decade. In other words, one unit of electricity consumption can support more than one unit of GDP. Two major reasons are proposed for the fall in electricity intensity: they are improvement in electricity efciency of electrical appliances and equipment, and conservation efforts to reduce electricity consumption. It is argued that electricity demand in China has shifted from quantitative to qualitative growth. Hence, it is not surprising to nd that rapid GDP growth did not lead to corresponding growth in electricity consumption. In order to overcome the constraints on electricity consumption, the Chinese government has to speed up the nation-wide interconnection of power networks, to upgrade urban and rural distribution grids, and to accelerate rural electrication. Tariff reforms are needed to remove the price differentials between rural and urban areas. These policies will have the effects of improving the efciency in power transmission and distribution, alleviating the problem of power shortages, and allowing the rural population to enjoy a higher level of electricity consumption when the economy of China continues to achieve remarkable growth.

Acknowledgements The authors would like to thank the Guangdong Electric Power Bureau, CLP Power China, and the Taiwan Power Company for arranging study visits. Thanks are also due to Pat Lam and Gary Sou for their assistance throughout the study. The work described in this paper was supported by research grants from The Hong Kong Polytechnic University (Project A/C code: G-T196; B-Q505) and the Research Grants Council of Hong Kong (CERG 01-02, PolyU 5213/01H).

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