Electricity prices for better yet sustainable economic performance

May 5, 2021

Energy efficiency is considered pivotal for long-term economic growth, especially since much of the energy consumed in Portugal has historically been from non-renewable sources.

According to the theory of directed technological change, whether firms are likely to develop and adopt technologies to increase the marginal productivity of energy (controlling for other production inputs) is decided by two counteracting effects: the price effect and the market-size effect. The price effect (often adopted by governments) tries to induce improvements in energy efficiency by imposing (through regulation) a higher energy price. Such practices, according to conventional belief, contribute to more economic growth but may also hinder economic activity via the high input price. Alternatively, the market-size effect may drive energy efficiency increases through high energy demand in the economy (which may come from low prices).

Based on microdata from various Portuguese economic sectors, this study looks at productivity sources for a sustainable economic performance. This study shows that the market-size effect is likely to overwhelm the price effect in Portugal based on evidence from a period where the fuel price (except natural gas) decreased and the electricity price increased in Portugal, while technological change favored fuel rather than electricity.

From this evidence, the paper concludes that a lower electricity price may promote the use of electricity in production. Since a large part of electricity generated in Portugal is from renewable sources, a trickle-down effect may be expected where investment is dedicated to develop or adopt technologies to increase the efficiency in using electricity.

The study suggests that policies that promote low prices can stimulate energy efficiency and economic growth.

Click here to go to the paper by Zheng Hou, Catarina Roseta Palma, Joaquim J.S. Ramalho.