Energy Diversification and Sustainable Economy Growth

Zuo hui1, Ai Danxiang2, Zhang Chengke1

1. School of Economics and Commerce, Guangdong University of Technology, Guangzhou City, China 2. School of Management, Guangdong University of Technology, Guangzhou City, China zuohui.gm@gmail.com
AbstractEnergy diversification is very important to the sustainable economy growth. In this paper we develop an endogenous growth model and analyze some major relationship between the energy diversification and sustainable economy growth. The dynamic optimization results of the model show that the technology progress will make great contributions to the energy diversification and the specialized energy R&D plays an important role in the energy diversification process, which can accelerates energy supply source expansion. Propelled by the specialized energy R&D, energy diversification will redistribute the labor force among different sectors, offset the adverse effects of diminishing marginal return of factors, and help economy step into sustainable growth eventually. Keywords- technical sustainable growth progress; energy diversification;

Kalicki 2007). According to Lesbirels (2004) research work, only specific risks (probably incurred by production shrinkage of some companies and countries) can be avoided by imports from many countries. With the probability of systematic risks in the global market of non-renewable energy, one country cannot secure energy supply without varietalness, which means diversification in energy variety. Konoplyanik (2005) and Dorian (2006) also regard that varietalness can free energy supply from restraint of fossil fuel reserves and smooth the fluctuation of energy markets, which is vital to economy growth and national security. According to Dirks (2006), energy diversification is a complicate construction including diversified imports, production, technology, infrastructures, market participants, trade contracts and so on, process of which is decentralization. In summary, there is sufficient study in the relationship between energy diversification and national security. However, little research work has been done about the impacts in the sustainable economy growth by diversification. We take a new look at the implications of energy diversification through the lens of endogenous growth theory. In particular, we use a model that achieves increasing scale effects through human capital accumulation with the restraint of energy in three interrelated sectors. The specialized energy research and development (R&D) sector provides energy technology to the energy producing sector and the latter produce energy to the manufacturing sector. Based on the dynamic optimization, we can study the importance of energy diversification as well as its implications on sustainable economy growth. Our main findings are that energy diversification is helpful to maintaining a preferable long run economy growth rate with specialized technology produced by the energy R&D sector. Interestingly, we conclude that economy can hardly sustain long run growth without energy diversification, even in circumstance of human capital accumulation and general technology progress in the rest sectors. II. THE MODEL

I.

INTRODUCTION

Energy diversification is thought to be one of the best solutions to breaking the restraint of non-renewable energy to economy growth. With the diminishing average energy consumption in unit product (thanks to the advance of energy saving technology), it seems that a country can step into sustainable growth in the long run. However, without diversification, energy saving can hardly solve all of the problems independently. Even if the non-renewable energy resources have not yet been exhausted, the cut-throat contention on them is easy to raise an energy crisis or even war. Currently, the majority of energy demand increment comes from developed countries, and with the economy growth of which, the geographical structure in non-renewable energy trade will change undoubtedly. Neither can energy saving strategy prevent competition for fossil resources, nor ensure that the economy growth of developing countries would not affected by energy shortage without the process of energy diversification. Vast literatures focus on the relationship between the national security and the energy supply. Intuitively, diversification, which means geographical distribution in importing crude oil and Liquefied natural gas to many countries, can prevent them from falling into energy shortage. Aftereffects of oil crisis gave sufficient evidence of the conventional views that diversified imports (from different counties) is helpful to eliminate the risks of non-renewable energy supply interruption (Yegin 2005, 2006; Bahgat 2006;

A. Overview We build our model based on the research work by Bauen (2006). To keep things as simple as possible, we measure the intensity of energy diversification by the increasing amount of energy supply sources that are provided either by different

This research is supported by Natural Science Foundation of Guangdong Province (10451009001004318).

978-1-4244-8694-6/11/$26.00 2011 IEEE

energy producers or in diversified variety. As we mentioned above, we assume that there are three sectors in the economy: the manufacturing sector, the energy producing sector and specialized energy R&D sector. Manufacture firms hire labor to produce differentiated consumption goods. In addition to labor, production of consumption goods also requires energy, which is supplied by the monopolistically competitive energy producers. Energy R&D sector produce specialized technology which is necessary in both the energy production and the development of new energy supply source. All of the manufacture firms and the energy producers can hire labor in a competitive market. Energy production benefits from both human capital accumulation and specialized energy R&D. B. Manufacturing sector The gross production by manufacture firms is defined as

manufacturing and energy R&D. MPL (Marginal Product of Labor) in the latter is APA L-1 .
While MPL of the former is ( Bu ) L1-1K
A 0

E i di .

To make things as simple as possible, we pass over the cost of energy transportation as well as the differences among natural properties of various kinds of energy. Therefore, prices among energy supply sources will be regarded as to be equivalent and it is reasonable to assume that the input of various energy supply sources is indifferent. We define E as the average input of energy source in the state of symmetry. When MPLs between the sectors of manufacturing and specialized energy R&D are equivalent, we have
APA = ( Bu ) L

L1-1K AE

(4)

Y = ( BuL1 ) K

A 0

E i di

(1)

where L1 is the labor hired by the manufacturing sector, K is capital stock, Ei is energy input and A is the total amount of energy supply source. (BuL1) can be seen as effective labor input including human capital. Provided constant return to scale, we have + + = 1 . For simplicity, we assume a constant accumulation rate of skill, so we have

E. Energy production Obviously, energy production of each energy supply source is decided by profit maximization of each energy producer. Provided that units of capital can produce one unit of energy on the average, marginal product of unit energy in symmetry state is

B = W (1- u ) B

Y 1 = ( Bu ) L1K E E A

-1

(5)

(2)

which can be seen as the price PE of unit energy. Therefore, total income of energy producers is

where B describe the skill of a representative worker, W is the human capital accumulation rate and u is the share of a unit non-leisure time which is used in production. A representative worker put into 1-u unit of non-leisure time for skill training.
C. Energy R&D In our model, the growth of the energy supply sources depends on the current intensity of specialized energy R&D activities, effective labor hired in energy R&D sector and total effective labor, as shown below

R E = PE E = ( Bu ) L1K E

(6)

When marginal cost of energy product equals to the marginal return, energy supply source maximized their profits, from that we have r=

R E = ( Bu ) L1K E

-1

(7)

where r is the marginal cost of capital.

F. Consumers We adopt a utility function of constant substitute elasticity.

BuL 2 L2 A = = A BuL L

(3)

where is the measurement of specialized energy R&D intensity. In energy diversification, any increment in amount of energy supply source involve sink cost, which exactly corresponds to the price of R&D work defined as PA. We assume that all researchers can use existing knowledge and all R&D work will be paid by corresponding technology users.
D. Equilbirum in labor force market With the assumption that there is no growth in population, we have L1 + L 2 = L . In competitive labor force market, there is no difference in the wages between the sector of

U (C) = by

C1- -1 1-

(8)

A representative consumer chooses to maximize his utility max

C

U ( C ) e- t dt

(9)

where is the discount rate.

G. Optimization Treating consumption as control variable and capital as state variable, we apply the optimal control theory and write Hamilton function as

III.

ENERGY DIVERSIFICATION AND SUSTAINABLE GROWTH

H = U (C) +

( Y - C) =
H =0 C

C1- -1 + K 1-

(10)

A. Specialized R&D and energy diversification From equation (19), we can infer that the greater the intensity of energy R&D activities is, the higher the increasing rate of energy supply sources is.

According to maximization conditions, we have (12) (13) (14)

K = Y - C - ( + )K = -

H K

where is the depreciation rate of capital. We define gx as the long run growth rate of variable x, e.g. gy is the long run growth rate of gross production. Provided long run capital-output ratio constant, we conclude that - gc = g = + + - r gY = gK = gc = r-( + + ) (15) (16)

measures the effects of specialized R&D work on energy diversification.

First, contributions of the R&D activities to energy diversification, more accurately, specialized technology produced by energy R&D sector, is relatively independent from the contributions made by average accumulation of human capital. The separation of the advance in specialized energy technology from the advance of general technology as measured by human capital accumulation shows that the diversification process is correlated with the specialized energy R&D intensity. From equation (22), it can be inferred that the contribution rate of specialized energy R&D to long run growth rate of energy supply sources is / ( + ) , which

(gK - gB )
+ r= L1

= gA =

L2 L

(17)

(1- )
= /( +

(18)

For the simplicity, we have

denotes

relative contribution share of human capital and u1 = L1 / L denotes the share of labor hired in the manufacturing sector. Therefore, we conclude that gY = gK = r= ( + ( + + ( gB + )
0 0

Second, there are differences between the effects of human capital accumulation and specialized technology progress on energy contributions. The former tends to increase the output of each energy supply source rather than increasing the amount of supply sources. From equation (19) and equation (22), it can be inferred that the sum of ge and ga equals to gY, which implies that whether economy growth can break away from energy restraints depends on the aggregated technological progress, which includes both human capital accumulation and specialized energy R&D work. Human capital accumulation tends to increase the output of each energy supply source, while specialized energy R&D tends to promote energy diversification. It also implies that only specialized energy R&D, especially innovation activities in diversification, can put technical progress into full play on the expansion in energy supply sources. It seems that government-led R&D is better than enterprises R&D in energy innovation, because the latter is likely in favor of expansion in energy output more than energy supply sources. Third, specialized energy R&D work achieves increasing scale effects in the expansion of energy supply sources, thanks to the dual contributions made by it. On the one hand, energy R&D advances specialization of energy supply sources and is likely to produce more energy supply sources, among which, some are the results of the horizontal expansion, i.e. brand-new energy supply sources brought by innovation, and others are the result of the vertical expansion, i.e. internal development in existing energy supply sources. On the other hand, specialized energy R&D increases marginal output of labor in the R&D sector, thereby higher the wages and make workers transfer to energy R&D sector. It implies that if investment in specialized energy R&D will bring about labor redistribution and make more returns by scale effect and knowledge spillover.
B. Energy diversification and economy growth With the specialized progress in the energy R&D sector, energy diversification can help economy break away from the

(19) (20)

gB + + ) gB + ( + ) gB +

L1 = u1 = L gA = u2 = where
0

(21) (22)

= + + .

restraint of energy and step into sustainable growth. Nonrenewable energy reserve confines sustainable growth and energy saving technological progress is hard to solve the problems of scarcity. Many countries witness the efficiency improvement as well as the boost of resource exhaustion. It implies that sustainable growth, especially in industrializing countries, demands continuous expansion of energy supply, which is mainly achieved by energy diversification rather than oil production. We also find that redistribution of labor force will impact economy growth with the development of energy diversification. From equation (19)-(22), it can be inferred that the variations of the specialized energy R&D intensity will change the investment returns in the energy production sector as well as the value of the specialized energy R&D work, thereby redistribute the labor force between the manufacturing sector and the energy R&D sector. It can be easily proved that labor hired in the R&D sector will transfer to the manufacturing sector as specialized energy R&D intensity, denoted by , decreases and the energy diversification process will terminate when is less than ( g B + . We 0) / have g E = g Y - g A < g Y which implies that sustainable economy growth is less demanding on energy production when diversification is still in effect. Nevertheless, when diversification process is terminated, energy production has to expand at the same rate with economy growth, which implies that we need more outputs from each energy supply source. Different from conventional wisdom, we think that specialized energy R&D plays an important role in sustainable economy growth, which cannot be replaced by average human capital accumulation. Energy diversification process will cease when specialized R&D work is terminated despite the accumulation of human capital. Specialized energy R&D and average progress of technology brought by human capital accumulation work together to maintain the expansion of energy supply in both vertical and horizontal dimensions. In vertical dimension, expanding energy supply can only rely to production of each energy supply source without diversification in horizontal dimension. In circumstance of that increase rate of average product of energy supply source cannot correspond with the demand, economy growth is hardly sustained. From equation (19)-(22), we can infer that energy supply source expand rate is highly correlated with the specialized energy R&D intensity, and the energy diversification process will cease when ( g B + , 0) / which implies that economy growth can hardly be sustained. IV. CONCLUSIONS

energy production sectors and there is little can be done when energy efficiency is considerable high without diversification. In endogenous growth framework, long term economy growth can be sustained with some factors maintaining a satisfying growth rate, which essentially breaks the rule of decreasing marginal return. However, as a special factor to production, energy has to be expanded horizontally because some nonrenewable resources will be exhausted sooner or later. Without specialized energy R&D work, it can hardly be ensured that current supply of energy can achieve an applausive growth rate meeting the increasing demand of economy growth completely, even if we have the similar rate of technology progress among all sectors in economy. It is very important to distinguish specialized energy R&D work from average technology progress. We find that it is necessary to maintain specialized energy R&D work intensity at a proper level, otherwise, energy diversification process will cease as no one is willing to work in the R&D sector. In our model, labor force will transfer freely among sectors and no worker is will to stay in the energy R&D sector if its progress is not enough to meet the demand of economy growth. Therefore, workers will transfer to the manufacturing sector from the R&D sector where they can get higher return and bring the energy diversification process to an end. The most interesting implication of the model is that the special contributions of diversification to sustainable economy growth demands government programing and financing, because there is a great deal of uncertainties in energy diversification process. Therefore, it is much safer to improve the production of a traditional energy source rather than develop a new one. Without government support, few enterprises can afford a considerable specialized energy R&D work continuously.
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