Highlights

  • Reductions in energy intensity is arguably our most important tool to achieve a sustainable energy future
  • Developed nations have reduced energy consumption since the financial crisis and the US has seen continued GDP growth
  • However, household income (proxy for living standard) has declined with energy consumption in the US
  • This trend poses serious questions about the feasibility of continued increases in living standards despite reductions in energy consumption

Introduction

A lot has been written recently about the decoupling between GDP and energy. This decoupling (shown for the IEA New Policies scenario below) is generally viewed as a central part of the solution to the the sustainability problems we face in the 21st century.

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Decoupling between economic growth and energy consumption is often attributed to energy efficiency, but in actual fact stems primarily from the general transition to more service-based value creation as economies mature. As an example, the graph below plots energy intensity in the US against the fraction of the economy dedicated to manufacturing (the balance being services), revealing a almost perfect correlation.

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Developing nations can therefore be expected to achieve substantial reductions in energy intensity over the coming decades as value creation is shifted more towards services. Developed nations, however, may be at the point where the economy is saturated with services, thus posing questions about whether these nations can further reduce energy intensity at meaningful rates.

Trends in developed economies

The ideal scenario in terms of decoupling is the achievement of a growing economy despite declining levels of energy consumption. Several developed economies have recently managed to achieve this goal for the first time in recent history following a seemingly structural change in energy consumption patterns after the great financial crisis and the spike in oil prices.

Between 2007 and 2013, primary energy consumption declined by 4.5%, 6.6% and 10% in the US, Euro Area and Japan respectively. However, as shown below, the US economy is the only one which managed to achieve any meaningful improvement in terms of per capita rate of production during this period. Note that the graph below uses NDP (Net Domestic Product) rather than GDP to better reflect actual production of useful goods and services (the primary difference between GDP and NDP is that NDP subtracts capital writedowns). Numbers are adjusted for purchasing power parity and inflation and were extracted from the OECD website.

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The use of NDP instead of GDP makes the US look better since capital writedowns are smaller relative to Europe and Japan, but I think this is a more representative measure than GDP. Overall though, the above graph suggests that US citizens are rapidly expanding the already large gap in living standards relative to their European and Japanese counterparts. As shown below (energy numbers from the BP Statistical Review), the US is also achieving rapid reductions in energy intensity and, although it still has some catching up to do, progress is better than in Europe and Japan.

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Overall then, the US appears to be the shining light in the story of continued economic expansion despite declining energy consumption. But is this really the case?

Energy and living standards in the US

In fact, an important worrying trend in the US has now gone on for so long that it is actually becoming a mainstream issue: stagnant wages. To summarize, when adjusted for inflation, current median household income in the US is at the same level as it was in 1995 – two decades ago! This is quite surprising given that NDP/capita has increased from $30000 to almost $40000 between 1995 and 2013 in the above graph.

There are three main reasons for this decoupling of per capita production and median wages:

1. Increasing profits. Businesses have been paying their workers a progressively smaller share of total revenue over the past three decades and using the resulting increasing profits to expand, pay more dividends and stockpile cash. In general, this trend implies that investment is increasing relative to consumption.

2. GDP deflator vs. CPI. GDP (and NDP) are adjusted with time via the GDP deflator which standardizes the value of domestic production, while wages are adjusted using the core inflation which tracks prices of a representative basket of goods and services (local or imported). This trend implies that the cost of living has been increasing faster than the cost of domestic production.

3. Increasing inequality. Income inequality in the US is rising sharply once more, thus reducing median wages relative to mean wages.

As a result, there appears to be very little decoupling between real household income (here seen as a proxy for living standards) and energy consumption. Income data in the graph below is from the US Census Bureau.

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It is clear that, from the time that household energy consumption actually started a structural decline (around 2000), the general standard of living in the US has declined in tandem. When looking at electricity consumption in the graph below, the trend becomes even stronger right across the 30 year sample period.

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Questions…

These trends pose some serious questions regarding the notion that rich nations can continue to increase living standards without increasing energy consumption (and the associated environmental impact). If it is really this difficult to achieve decoupling in nations enjoying decent standards of living, the world will need to quadruple energy consumption in order to bring the global population to current developed world standards. This will not be possible without some real technological miracles.

One would therefore very much like to believe that Europe and Japan will one day manage to achieve a meaningful economic recovery and that the recent divergence between household income and domestic production in the US will reverse.  However, Japan has recently completed its second “lost decade” while Europe followed suit with its first. In addition, one can argue that persistently low wages coupled with increasing inequality is an important part of the reason why US GDP could continue expanding while Europe and Japan stagnated.

What do you think? Will the developed world be able to successfully decouple living standards from energy consumption? What needs to be done to break the worrying trends discussed in this article?

Energy Collective