Recessions, creative destruction, and the shift to a greener energy mix

Recessions, creative destruction, and the shift to a greener energy mix 1

Pragyan Deb, Davide Furceri, Jonathan D. Ostry, Nour Tawk 31 January 2022

The COVID-19 recession reduced overall energy demand, but electricity generation from renewable sources increased and has been resilient. Based on data from a panel of 176 countries over the period 1965 to 2019, this column shows that recessions result in a permanent, albeit small, increase in energy efficiency and in the share of renewables in total electricity. These effects are stronger when complemented with environmental and energy policies to incentivise and hasten the transition towards renewable energy sources.

Lockdowns resulting from the COVID-19 pandemic reduced overall energy demand in 2020. However, electricity generation from renewable sources was surprisingly resilient and, as a result, the share of renewables in electricity demand increased in many regions (International Energy Agency 2020). What remains an open question is whether recessions of themselves tend to spur investments in more efficient, greener, energy sources, or instead to continue investing in old coal-based plants. On one hand, the disruption in financing engendered by the crisis may reduce innovation through lower research and development, which is highly procyclical (De Haas et al. 2021). On the other, lower energy demand and associated plant closures brought about by the recession may provide energy producers with an opportunity to improve their efficiency by replacing older environmentally unfriendly plants with renewable sources of energy when demand recovers. The idea that outdated units are destroyed and replaced by newer technological innovations goes back to Joseph A. Schumpeter’s thesis on ‘creative destruction’ (Schumpeter 1939, 1942), with economic disruptions such as the one brought about by the pandemic acting as a time of cleansing (Caballero and Hammour 1994). 

Impact of recessions on energy use and mix

We go to the data to answer this question in our new research (Deb et al. 2021). Specifically, we investigate the response of the share of renewable energy in total energy to major historical recessions (including financial crises and pandemics) for a panel of 176 countries over the period 1965 to 2019, using the local projection methods proposed by Jordà (2005). 

The results suggest that recessions are associated with a significant decline in energy use. While the initial decline is in line with the decline in output, with no statistically significant change in energy intensity, over time as output recovers, energy use rises at a slower pace than output and is permanently lower relative to a baseline of no recession. As a result, energy intensity declines over the medium term.  

Beyond this, the energy mix becomes greener after a recession, with the share of electricity generated from coal declining by about 1% after five years, while the share of renewables increases by almost 2% (Figure 1). In other words, we find that recessions – such as the associated with the COVID-19 pandemic – tends to accelerate the underlying trends towards renewables. 

Figure 1 Changes in energy mix after recession (change in the share, %)

Recessions, creative destruction, and the shift to a greener energy mix 2

Source: Deb et al. (2021)
Note: Impulse response functions are estimated using a sample of 172 countries over the period 1985–2019. The graph shows the response and 95% and 90% confidence bands. The x-axis shows years after the event, with t=0 is the year of the recession.

Role of environmental policies

Policy can be a powerful tool in accelerating the shift towards a greener energy mix following recessions (OECD 2010, Persaud 2021). Bowen and Stern (2010) argue that downturns provide a “very good opportunity to undertake a necessary step change in the public spending component of environmental policies and to start working through a backlog of public investment to improve the environment”. Environmental protection schemes (EPSs) can boost the transition towards renewable energy, with high EPSs associated with an increase in the share of renewables in total electricity after a recession, while the effect is not statistically significant in regimes with low EPSs (Figure 2). While on average a recession is associated with a two percentage points increase in the share of renewables, countries with high EPSs see a much larger increase – almost double at around four percentage points. Market-based EPSs – such as taxes on pollutants, trading schemes such as carbon trading, energy saving and green energy certificates, and feed-in-tariffs for renewables – are most effective in accelerating the shift towards a greener energy mix. Non-market-based EPS – such as emissions and fuel standards and R&D incentives – are also associated with an increase in the share of renewables after a recession.

Figure 2 Impact of environmental protection schemes 

Recessions, creative destruction, and the shift to a greener energy mix 3

Source: Deb et al. (2021)
Note: Bars show the impact of growth slowdowns after five years on energy mix estimated using a sample of 33 countries over the period 1990–2015. We use a smooth transition autoregressive model to formally assess the impact of Environmental Protection Schemes (EPS) in affecting the energy mix after a recession, with the red bars showing the impact at high EPS regime while the grey bar showing the impact at low EPS regime. 
  

Recessions, such as the current one, provide a window of opportunity to achieve a more resilient and greener recovery (Georgieva 2020), including as a result of the creative destruction that often accompanies downturns. Although climate change and clean energy policies can engender opposition from energy-using industries and the public at large, and thus may lead to electoral costs for incumbent politicians, these costs can be avoided if the design of mitigation policies takes into account political economy dimensions and if complementary policies are deployed to protect vulnerable households (Furceri et al. 2021). 

Note: The views expressed in this column should not be ascribed to the institutions with which the authors are affiliated.  

References

Bowen, A and N Stern (2010) “Environmental policy and the economic downturn”, Oxford Review of Economic Policy 26(2):137-163.

Caballero, R J and M L Hammour (1994), “The cleansing effect of recessions”, American Economic Review 84(5): 1350-1368. 

De Haas, R, R Martin, M Muuls and H Schweiger (2021), “Barriers to net zero: How firms can make or break the green transition”, VoxEU.org, 19 March.

Deb, P, D Furceri, J Ostry, and N Tawk (2021), “Creative destruction during crises: An opportunity for a cleaner energy mix”, CEPR Discussion Paper 16819.

Furceri, D, M Ganslmeier, and J D Ostry (2021), “Design of climate change policies needs to internalise political realities”, VoxEU.org, 7 September. 

Georgieva, K (2020), “The long ascent: Overcoming the crisis and building a more resilient economy”, speech at the 125th Anniversary of the London School of Economics, 6 October.

International Energy Agency (2020), Sustainable recovery, World Energy Outlook Special Report, June.

Jordà, Ò (2005), “Estimation and inference of impulse responses by local projections”, American Economic Review 95(1):161-182.

Organisation for Economic Co-operation and Development and M Ash (2010), “Taxation, innovation and the environment”, OECD.

Persaud, A (2021), “Three changes to the regulatory framework for renewable energy to help save humanity’s future”, VoxEU.org, 23 February. 

Schumpeter, J A (1939), Business cycles: A theoretical, historical, and statistical analysis of the capitalist process, McGraw-Hill.

Schumpeter, J A (1942), Capitalism, socialism and democracy, New York: Harper, republished 1975.

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