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m o du l e I-3 : Energy and economic issues

I N T RO D U C T I O N
Energy demand in developing countries will
rise enormously as per capita incomes and
populations grow. By reference to the situations
of people without access to modern energy
forms, the chapter shows why energy is an
economic good and thus why energy supplies
will need to be expanded to meet emerging
demands if living standards are to be improved
and developing countries are to achieve eco
nomic prosperity. Energy demand in industrial
ized countries is also likely to remain strong,
notwithstanding and to some extent, because
of continuing gains in the efficiency with
which energy is produced and used. Both
energy resources and financial resources are
amply available to meet market needs.
However, will solving the pollution problem
from energy use prove too costly from an eco
nomic perspective? There is no evidence that it
will, and most assessments point to the likeli
hood of an improvement, not a deterioration, in
economic prospects with enlightened environ
mental policies. Technologies are now available
for addressing the most serious forms of local
and regional pollution from fossil fuel use at
costs that are small in comparison to the costs of
energy supplies. Consequently, there is every
reason to be sanguine in this respect. In fact,
developing countries are in a position to address
their local and regional pollution problems at a
far earlier phase of development than were the
industrialized countries before them within
the first third of this century if they wish.
Furthermore, there are highly promising options
for addressing global warming in the long term
renewable energy, hydrogen-related technolo

gies and fuel cells, for example which could be

developed through enlightened research, devel
opment and demonstration policies.
Therefore, much will depend on energy and
environmental policies. In reviewing the ground
rules for such policies, this chapter shows that
the aims of developing countries for achieving
economic prosperity and of industrialized coun
tries for improving their economies are fully
consistent with those of simultaneously meeting
rising world demand and realizing a low-pollu
tion future.
ENERGY CONSUMPTION AND ECONOMIC
WELL-BEING
No country has been able to raise per capita
incomes from low levels without increasing its
use of commercial energy. Energy is an impor
tant input into production processes, which can
improve economic productivity.
Modern energy forms are an economic good,
capable of improving the living standards of the
billions of people, most in developing countries,
who lack access to energy services or whose
levels of consumption are far below that of
industrialized countries. It is the pollution from
energy production and use, not energy itself,
which is an economic bad given the often
hidden costs pollution imposes on societies.
Large regions of the developing world are
making the transition from traditional to mod
ern energy sources at a much earlier phase of
development than was the case for industrialized
countries. In the United States, the transition
took 70 years (1850-1920) by which time
average per capita income was $5,000 per year.
In developing countries today, the transition is

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F IG URE I. 3A

and groundwater resources and even

on biodiversity. The dangers of flash
flooding are also reduced. If modern
fuels replace the quantity of wood,
y(59=100)
dung and crop residues for cooking,
it would represent only 3 percent of
current oil and gas consumption.
Gains in energy efficiency. The
transition to modern fuels can lead
to large gains in energy efficiency.
A rise in commercial energy use
amongst the poorest people in the
world reduces their energy demand,
a pattern that continues until

incomes reach quite high levels.

USE OF BIOMASS AS A COOKING FUEL RELATIVE TO

GNP PER CAPITA IN 80 CO U N T R I E S

GNP per person (1998 US $)

S O U RC E :

Wo rld En e rgy As s e s s m e nt (2000)

nearly complete at roughly $1,000 per year.

The main reasons are technological progress
in energy exploration and production, more
abundant energy supplies and the lower energy
costs today.
The benefits of service extension are:
Savings in time and labour in the home.
When wood fuel is scarce, the time people
spend collecting fuel is time they cannot
devote to productive activities. When used
for pumping water, modern energy sources
also improve access to water. In addition,
savings in time and labour also occur with
the economic convenience of modern energy
forms and the advances they make possible
(hot and running water, washing machines,
refrigeration, food and crop processing,
extension of the day with electrical lighting).
Reductions in pollution and improvements in
health. The use of modern fuels reduces the
level of indoor air pollution by several orders
of magnitude. Indoor air pollution is prima
rily due to the use of traditional biomass.
Reductions in environmental damage. The
transition to modern fuels reduces pressure
on forests and land and thus on watersheds

Countries that have been able to raise overall

economic productivity and incomes on a broad
basis through good macroeconomic manage
ment, trade and investments in human and
physical capital - have been able to extend
services more rapidly.
In a number of developing countries, the
import of oil absorbs a large share of total
export earnings. While low oil prices in the
1990s benefited such countries periods of high
oil prices, such as those experienced during
2004, exacerbate these problems.

World Energy Assessment,

Chapter 11, pages 395-399
Specific to the sensitivity of
d eveloping economies to oil impor t s :
World Energy Assessment, pages 31-37.

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E N E RGY USE FORECA S TS AND ENERG Y

EFFICIENCY
Per capita consumption levels of commercial
energy and electricity in developing countries
are barely one-tenth of those in OECD coun
tries, while their populations are five times
higher. Energy scenarios point to an increase in
the worlds consumption of commercial energy
over this century of roughly 2.5 to 5 times
todays levels, but vary considerably depending
on assumptions about growth in income and
populations, but also in energy efficiency.
The possibilities of further gains in energy
efficiency are far from exhausted. Thus, develop
ing countries are likely to need less energy to
produce a unit of GNP and to meet consumer
needs per unit of income than was the case
for industrialized countries. However, no empir
ically based study has shown that developing
countries can achieve prosperity without very
large increases in demand for energy, even
with strong assumptions about improvements
in energy efficiency.
There are two principle effects on energy
demand linked to energy efficiency: energy
efficiency as a means of reducing energy demand
for a particular purpose and energy efficiency as
a means of reducing the price of energy and
t h e reby raising demand (sometimes ca lled the
rebound effe c t). Studies so far have been incon
clusive about which will prevail and when duri n g
the course of deve l o pment. This explains some of
the diffe rences in the fore casts in increases of
energy demand.
The argument that energy efficiency
will reduce environ
World Energy
mental damages is
Assessment, Chapter of limited value
11, pages 399-400
when one considers
the rebound effect

and the fact that improved energy efficiency

makes energy more affordable and accessible to
customers, which is particularly important for
developing countries.
RECONCILING INCREASED ENERGY
CONSUMPTION AND ENVIRONMENTAL
P ROTECTION
Reducing local and regional pollution
There are high social costs of pollution
from energy production and use in developing
countries. Primarily in the form of high health
damages, these high social costs are due to the
use of diesel-powered vehicles, small stoves or
boilers burning coal, wood or oil, high sulphur
deposition rates, the use of small (low) smoke
stacks and the choice of fuel.
Although energy consumption per capita is an
order of magnitude higher than in developing
countries, local and regional pollution is an
order of magnitude or more lower or headed
in that direction in industrialized countries.
Low-polluting technologies, in wide use in
industrialized countries have led to appreciable
reductions in smog, acid deposition and emis
sions of lead, particulate matter and volatile
organic compounds (VOCs).
Given the time required to incorporate
low-polluting options in new investments
and to replace the old capital stocks, pollution
is likely to rise in developing countries before
it falls. However, the potential for innovation
and existing technologies allows developing
countries to address environmental problems
at an earlier phase of their development than
did industrialised countries.
The costs of controlling local and regional
pollution are small relative to the total costs
of energy supply or use. For example, if coal is
being used, the costs of pollution abatement

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range from 2 percent of supply costs for

particulate matter to 5-10 percent for acid
deposition.
The relatively low costs of pollution control
suggest that the required financing can be
generated through policies that allow prices
to reflect the marginal costs of supply,
including the cost of pollution control the
central goal of internalizing externalities in
market prices. Studies consistently show
that the extra investment would become
self-financing and would over time be offset
by efficiency gains in the industry.
The effect of pollution control regulations
on GDP growth and other macroeconomic
indicators is relatively small while these
negative effects fail to take into account
most of the benefits, such as improvements
in peoples health and reduced dam
age to natural
World Energy
resources.
Assessment,
Chapter 11,
pages 395-399

energy, the uncertainties remain considerable.

The future use of renewable energy will depend
on its costs relative to the costs of fossil fuels
and on taxes and regulation of carbon emissions.
FIGURE I.3B

SIMULATED EFFECTS OF ENVIRONMENTAL

POLICY ON CARBON DIOXIDE EMISSIONS FOR
A DEVELOPING CO U N T RY
H a l f - c e n t u r y delay in policy introduc t i o n
Per capita income

Early polic y introduct i o n

Time (ye a r s )
SOURCE:

Special run by the author using the model descri bed in Anderson and Cave n d i s h , 1999.

N o te : Initial GDP per capita is $1,500 and growth is 3 percent a ye a r. The early fluctuations
in emissions in the early policy case arise from the initial price effects on demand.

In addition, competition from fossil fuel

reserves continues to increase. Estimates of fossil
fuel reserves are far greater today than they were
40 years ago. Except during the oil price shocks
of the 1970s, i n f l a t i on-adjusted oil prices have
c on s i s t e n t ly been in the $10-20 per barrel range
(in 1995 dollars) for the last 120 ye a r s , despite
the huge increases in demand. Low costs are
made possible not on ly by continued discoveries,
but also by technological progress in explora t i on
and pro d u c t i on and throughout downstream
industries. While high oil prices are now being
e x p e rienced (2004), it is
not known how long this
World Energy
pressure will remain.
Assessment,

REDUCING GLO BAL POLLU T I O N

Developing countries have been reluctant
to commit themselves to emission reduction
targets for greenhouse gases because the costs
are thought to be too high and there is resistance to the notion that developing countries
should not use fossil fuels to further economic
development.
Yet, some countries such as Brazil, China
and India have been putting resources into
renewable energy technologies. The technologies are promising because of the abundance of
renewable energy sources and the falling costs
being brought about by technical progress.
Notwithstanding the promise of renewable

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Chapter 11,
pages 404-408

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L I B E RA L I S ATION AND GLO BA L I S AT I O N

In the past half century, successive multilateral
rounds of reduction in barriers to trade and
foreign investment have led to considerable
increases in the level and globalisation of eco
nomic activity. Foreign direct investment also
expanded rapidly, encouraged by liberalization
and privatization.
In the energy industry, liberalization was
seen as a response to an array of problems and
opportunities:
The growing difficulties of raising finance.
The growing difficulties of the public
sector in providing for the financial losses of
state-owned industries.
Deteriorating service levels in many
countries, reflected in frequent black-outs
and brown-outs.
The need to reduce losses and cost

inefficiencies.

The increasing transparency of costs

and investment decisions in the electricity,
nuclear power and coal industries in
particular, which have led to the increased
questioning of the cost-efficiency of public
investment in the energy industry.
The rapid growth of energy markets in
developing regions and related opportunities
for trade and investment in high-efficiency
technologies.
The increasing integration of the world econ
omy has raised fears that the most impoverished
people will be left out of the process of econom
ic growth and development - that only higher
income groups will benefit and that inequality,
poverty and social conflict will intensify. They
also fear that there will be deleterious effects on
the environment.
If complementary policies are in place, the rate
of economic growth and development on a

broad basis will be higher under liberalization.

These include environmental policies, but also
health and population, agricultural extension,
vocational training, physical infrastructure and
social infrastructure, including a regulatory
framework for industry and commerce. How
ever, if these policies are not in place, some of
the fears may be well founded.
The problem of access will be the greatest
challenge. It is clear that industry will need
appropriate regulatory frameworks to accom
plish the provision of access to energy services
to the 6 billion new customers expected in this
century alone. These frameworks will also need
to ensure that widening access to energy services
is a goal of the industry in addition to the usual
goals of avoidance of monopoly and economic
efficiency.
CO N C LU S I O N : E CONOMIC PERSPECTIVES
ON POLICY
Over the next half-century, the energy industry
will need to reach another 6 billion people or
more depending on population growth while
also meeting the rising demands of the 4 billion
people already served. It will need to do this
while substantially reducing local and regional
pollution levels, particularly in developing
regions where the task of pollution abatement
has hardly begun and while developing new
technologies and practices for reducing global
carbon emissions and other greenhouse gases in
the long term.
Several lessons of experience and ground
rules for policy can be derived from a large
number of studies that have reviewed energy
and environmental policies:
The extension of modern energy supplies
to people currently without them cannot be
accomplished by the industry acting in isola-

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tion, but will depend on the quality of overall

development policies and the economic
growth necessary to ensure peoples ability to
afford and use modern energy services.
The liberalisation of energy markets, which
experience has shown to be fundamental for
the efficient growth of the industry, is also
crucial for widening access.
The goals of liberalization extend to trade
and foreign investment in energy technolo
gies and services given the considerable
financial, technical and managerial resources
of the energy industry that could be applied
to improving and extending energy supplies.
Economic efficiency provides a good basis
for regulation. Regulators must consider
measures of cost and price efficiency, at envi
ronmental performance and at the industrys
efforts to extend service to assess an indus
trys performance. Some key areas are: price
efficiency, subsidies, cost efficiency, quality of
service, widening access and commercializa
tion policies for environmental innovation.
Taxing energy is not an effective instru
ment of environmental policy, notwithstand
ing many claims to the contrary. If pollution
is to be reduced, there is no substitute for
direct taxation or the regulation of polluting
emissions.
There is no reason, from either a techno
logical or an economic standpoint, why
the world cannot enjoy the benefits of both
high levels of energy use and a better envi
ronment, since technological and managerial
options are already available or capable
of being developed that can address environ
mental problems at costs that are large in
absolute terms, but small in comparison to
the cost of energy supplies in the long term.
In light of the new environmentally

friendly energy technologies on the one

hand and of emerging environmental
problems on the other, there is a good case
for revisiting the role of technology policies,
including public support for research,
development and demonstration (RD&D).
While there is ample evidence of market-led
technical progress in the energy sector, many
have argued for public or regulatory support
for the industry to develop new non-fossil
fuel technologies in response to concerns
about climate change, since the industry
might otherwise have ignored these areas
because of the abundance of fossil fuel
reserves.
In view of the climate change problem,
energy technology development and com
mercialization programmes for climate
friendly technologies also need to become
more outward looking and international in
scope to include developing countries
(Global Environmental Facility; Joint
Implementation and the Clean Development
Mechanism; and regulatory and tax
incentives).
Financial analysis consistently shows that,
under enlightened regulation, the energy
industry is capable of mobilizing the financial
resources required to expand services and
address environmental problems through a
mix of internal cash generation and recourse
to the financial markets.
World Energy
Assessment,
Chapter 11,
pages 409-411

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ADDITIONAL LITERATURE RESOURC E S

ESMAP (2002) Rural Electrification and Development in the Philippines: Measuring the Social and
Economic Benefits UNDP/World Bank programme.Washington D.C.: The World Bank. This report is an exam
ple of the application of quantitative methods to assess the value of the benefits of extending electricity
to rural areas. The report is intended for the technical reader.
OECD (1991) Energy Prices, Taxes and Carbon Dioxide Emissions Working Paper no. 106. Paris: OECD.
Reviews technical and policy issues in relation to the use of taxes as an economic policy instrument to
reduce carbon dioxide emission in OECD countries. Intended for the technical reader.
UNDP (2000) Sustainable Energy Strategies: Materials for Decision-Makers New York: United Nations
Development Programme. Intended to provide support for capacity development for sustainable energy
programmes and policies at the country level, Chapter 6 focuses on promoting institutional changes for
sustainable energy.
UNDP (2002) Energy for Sustainable Development: A Policy Agenda Thomas B. Johansson and Jos
Goldemberg (eds.) New York: United Nations Development Programme. This publication focuses on policy
options and effective implementation and offers informed guidance on the next steps and on how to
shape public policy so that it accelerates the growth of energy systems that support sustainable develop
ment. Chapter 2 focuses on how to make markets work better.
World Bank (2000) Energy and Development Report 2000: Energy Services for the Worlds Poor
Washington D.C.: The World Bank. This report on energy and poverty alleviation serves as a resource for
developing country governments and for all other players in the energy sector for: (1) understanding the
challenge of expanding access to energy for low-income households and communities in developing
countries, (2) facilitating technological and commercial innovations in serving the poor, through market
structure and regulatory reform and (3) reducing financial, legal, regulatory, and tax barriers to better
services for low-income households and areas.
[http://www.worldbank.org/html/fpd/esmap/energy_report2000/index.htm]
World Bank (2001) Impact of Power Sector Reform on the Poor Washington D.C.: The World Bank.
Prescriptions for the commercialization, restructuring and privatization of the energy sector (Box 1) are
now in fashion. They are actively promoted by donors but fiercely decried by opponents. One crux in the
debate is the apprehension that these reforms are a setback for the poor. The present note reviews the
issues and the literature. Its objective is to inform rather than settle the debate and to suggest orientations
for future research .Its focus is on the power sector and on developing countries.
[http://wbln0018.worldbank.org/infrastructure/infrastructure.nsf/e6cf3abdea7d4cbd852569b400694cee/8
525690b0065f5d1852568a30057dad8?OpenDocument]
continued on next page

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ADDITIONAL LITERATURE RESOURCES co n t i n u e d

World Resources Institute (2002) Power Politics: Equity and environment in electricity reform Washington
D.C.: World Resources Institute. This study is motivated by a concern that attention to environmental and
social public benefits be included as an integral part of reforms in the electric power sector. The central
question is: how can reforms that are sweeping the electric power sector promote rather than hinder pro
motion of a public benefits agenda? Includes case studies from Argentina, India, Indonesia, Bulgaria,
Ghana, South Africa. [http://climate.wri.org/pubs_pdf.cfm?PubID=3159]
World Energy Council (2001) Pricing Energy in Developing Countries London: World Energy Council. This
Report draws upon the Three Energy Goals identified in the World Energy Council's (WEC) millennium
statement, "Energy for Tomorrow's World - Acting Now", published in April 2000. These three goals of
Energy Accessibility, Availability and Acceptability (the three A's of sustainable energy systems) are closely
interlinked and should be the pillars of energy pricing policies, not just in developing countries but also in
any market. Because of the special problems developing countries face, the Report focuses on their pricing
practices and draws, from specific cases, basic principles for better pricing policies which can help them
achieve the three A's. Includes case studies on Argentine, India, Iran, Jordan, Mexico, Peru, South Africa,
Thailand and Turkey. [http://www.worldenergy.org/wec-geis/publications/default/launches/pedc/
pedc.asp]

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