From Theory to Econometrics to Energy Policy: Cautionary Tales for Policymaking Using Aggregate Production Functions

Matthew K. Heun, João Santos (), Paul E. Brockway, Randall Pruim, Tiago Domingos and Marco Sakai
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Matthew K. Heun: Engineering Department, Calvin College, Grand Rapids, MI 49546, USA
Paul E. Brockway: Sustainability Research Institute, School of Earth and Environment, University of Leeds, Leeds LS2 9JT, UK
Randall Pruim: Mathematics & Statistics Department, Calvin College, Grand Rapids, MI 49546, USA
Marco Sakai: Sustainability Research Institute, School of Earth and Environment, University of Leeds, Leeds LS2 9JT, UK

Energies, 2017, vol. 10, issue 2, 1-44

Abstract: Development of energy policy is often informed by economic considerations via aggregate production functions (APFs). We identify a theory-to-policy process involving APFs comprised of six steps: (1) selecting a theoretical energy-economy framework; (2) formulating modeling approaches; (3) econometrically fitting an APF to historical economic and energy data; (4) comparing and evaluating modeling approaches; (5) interpreting the economy; and (6) formulating energy and economic policy. We find that choices made in Steps 1–4 can lead to very different interpretations of the economy (Step 5) and policies (Step 6). To investigate these effects, we use empirical data (Portugal and UK) and the Constant Elasticity of Substitution (CES) APF to evaluate four modeling choices: (a) rejecting (or not) the cost-share principle; (b) including (or not) energy; (c) quality-adjusting (or not) factors of production; and (d) CES nesting structure. Thereafter, we discuss two revealing examples for which different upstream modeling choices lead to very different policies. In the first example, the (kl)e nesting structure implies significant investment in energy, while other nesting structures suggest otherwise. In the second example, unadjusted factors of production suggest balanced investment in labor and energy, while quality-adjusting suggests significant investment in labor over energy. Divergent outcomes provide cautionary tales for policymakers: greater understanding of upstream modeling choices and their downstream implications is needed.

Keywords: energy policy; econometrics; CES; Solow residual; cost share principle (search for similar items in EconPapers)
JEL-codes: Q Q0 Q4 Q40 Q41 Q42 Q43 Q47 Q48 Q49 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

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