ENERGY SECTOR INNOVATION, TECHNOLOGY EXTERNALITIES,
AND MACROECONOMIC GROWTH
Xinya Zhang, Rice University, Phone +7132983153, E-mail:[email protected]
Overview
Many studies assume that the optimal size of research and development (R&D) in the energy sector is five to ten
times the current level. Is the energy sector under-investing in R&D? What would be the effects of subsidies to
R&D in renewable energy on macroeconomic growth? As the new administration devotes substantial resources
to production and investment subsidies in the renewable energy and biofuels sector, it is important to evaluate
the validity of such a strategy.
The paper studies the optimal transition from fossil fuels to renewable energy in a neoclassical growth economy
with endogenous technological progress in energy production. More specifically, innovations control fossil
energy cost even as increased exploitation raises mining costs, while in the renewable sector, accumulated
knowledge lowers unit production cost until a technological limit is attained. I then study the consequences of
such innovation for macroeconomic growth. Then I discuss different scenarios with technology spillover and
compare their competitive equilibrium allocations to the optimal one. I will talk about the role of government
and the effects of policy when externalities exist in the end.
Methods
I build a quantitative dynamic general equilibrium model in which to study technological progress in both fossil
fuel and renewable energy sectors and its consequences for macroeconomic growth. After I calibrate the model
using data on world energy consumption and production and cost data from the US, I solve the model backwards
in MATLAB. Specifically, in the backwards solution, we know the values of the co-state variables at the various
transition points. The known initial values of the state variables (from calibration) at t=0 become targets, and we
have three free variables to set in order to hit these three target values.
Results
Absent any externality and government intervention, the economy goes through three distinct regimes related to
energy production. Initially, production uses fossil fuel only, and investment takes place in order to improve the
efficiency of supplying fossil fuel. In the medium to long run, as the price of fossil fuel inevitably increases,
investment and capital accumulation slow down. The economy then makes a transition to the rest of two
renewable energy regimes (Figure 1). Subsequently, learning-by-doing reduces the cost of producing capital
using the backstop technology. Finally, in the very long run, a transition to the second renewable energy scheme
occurs. Here, a limit is reached after which renewable energy is produced at the lowest possible cost (Figure 2).
Figure 1
Figure 2
In the decentralized model with technology externality, there is an under-investment in R&D compared to the
social planner model above. As a result, the technology in the renewable sector reaches its frontier 8 years later,
while the capital stock is 16.74% less at the transition point.
Conclusions
We study the optimal transition path from fossil fuel to renewable energy sources in a neo-classical growth
economy and account for externalities associated with the possibility of under-investment in R&D. We find that
with externalities, the market and optimal allocations are substantially different suggesting a role for the
government. And based on current results, both taxing fossil fuels and subsidy on investment in renewable
energy accelerate the rate of adoption of the renewable energy technology.
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