Energy Consumption and Economic Growth in Pakistan Muhammed Zeshan Vaqar Ahmed Sustainable Development Policy Institute

1. Bulletin of Energy Economics
http://www.tesdo.org/JournalDetail.aspx?Id=4
Energy Consumption and Economic Growth in Pakistan
Muhammad Zeshan* a, Vaqar Ahmed a
a
Sustainable Development Policy Institute, Islamabad, Pakistan
Abstract
The present study investigates the impact of energy consumption on real GDP, capital stock, and
labor force using annual data for the period of 1971-2012. For empirical analysis, it employs the
Structural Vector Auto-regression (SVAR) framework. The results reveal that economic growth
increases the demand for labor force, but this rise is not sustainable. Same is the case for other
factors such as capital stock and energy. We see that greater energy inputs are required to
facilitate the new additions to capital stock. Further, an exogenous shock to capital stock and
labor force stimulates the economic activity temporarily. Rising capital stock also demands
greater units of labor as productive activity expands in the economy. The research work
recommends the government to focus on its supply-line. A certain and affordable power supply is
the need of time.
Keywords: Energy, Growth, Pakistan
JEL Classifications: Q4, O1
I. Introduction
The causal linkages between energy consumption and economic growth are of great interest to policy
makers owing to their significance in the policy making process. The first empirical support of the topic
in hand was provided by Kraft and Kraft [1]. It finds a unidirectional causal relationship from economic
growth to energy consumption. This research work motivated various other empirical studies to identify
such causal links (Apergis and Payne [2], Abosedra et al. [3]). It is believed that energy consumption is an
important ingredient of economic growth, it is the key to stimulating macroeconomic growth. If there is
empirical support of growth hypothesis, restricting the energy consumption can adversely affect the
growth process1. In contrast, if there is empirical support for the conservation hypothesis, the policy
makers support the energy conservation policies2. Nonetheless, the existing empirical literature does not
provide enough evidence to establish a universal causal relationship between energy consumption and
economic growth (Karanfil [4]). Policy makers face various obstacles during the policy making process
(Ozturk [5], Payne [6]). Karanfil [4] states that ignoring the potential variables in the empirical research
produces misleading causality relationships. Hence, in order to minimize the potential variable gap, many
empirical studies starting using other indicators such as labor employment, CO2 emissions, exports,
urbanization, financial development, and foreign direct investment (Shahbaz et al. [7], Shahbaz and Lean
[8], Ciarreta and Zarraga [9], Chandran et al. [10], Lean and Smyth [11], Sadorsky [12] and Tang, [13]).
I.I Pakistan’s Context
The historical macro-economic scenario in Pakistan reveals a declining real GDP growth rate; the real
GDP growth rate has been the highest during the 1980s and the lowest during 1990s. The fixed
investment to GDP ratio remained stable during 1980s and 1990s, but it declined during 2000s. The
Corresponding Author’s Email: zeshan@sdpi.org
1
A unidirectional causality from energy consumption to the economic growth is known as the growth hypothesis.
2
A unidirectional causality from economic growth to the energy consumption is known as the conservation
hypothesis.
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growth rate in labor force has been more negative during 1970s, 1980s and 2000s. However, the GDP
deflator shows a rising trend indicating the persistent inflationary trend. Finally, energy intensity
indicated by energy consumption to GDP ratio remains the same during the period of analysis.
Table-1: Economic Growth and Energy Consumption Trends
Time
1970s
1980s
1990s
2000s
Real GDP Growth
5.195
6.289
3.956
4.402
Fixed Investment to GDP ratio
16.382
18.720
18.559
17.677
Labor Force Growth
-0.004
-0.706
3.088
-5.288
GDP Deflator
11.489
24.945
61.833
180.455
Energy Consumption to GDP Ratio
0.002
0.002
0.002
0.002
Source: World Development Indicators
The growth rates of capital stock and real GDP portray a positive relationship and same is the case with
growth rates of labor force and the real GDP. Nonetheless, the relationship is much stronger between the
capital stock and the real GDP. The analysis reveals that initially, there was a weak relationship between
labor force and capital stock which improved in the later years. It is observed that growth in labor force,
capital stock and real GDP were at their minimum level in the years 2010, 2001 nd 1971 respectively. It
was at the peak during the year 2007, 2006 and 1980 respectively. Their average growth rates for all of
the period of analysis are 2.90 percent, 0.89 percent and 2.26 percent respectively. Decomposing it for
each decade, it reveals that the labor force was increasing rapidly during the 1970s while the capital stock,
real GDP and energy consumption were performing their finest job in the 1980s, see Figure 1-3 and
Table-2 for more details3.
20
10
Figure-1 Capital Stock and Real GDP
0
-10
19711973197519771979198119831985198719891991199319951997199920012003200520072009
K
G
-20
Source: World Development Indicators and Author’s Calculations
10
8
Figure- 2 Labor Force and Real GDP
6
4
2
0
-2 19711973197519771979198119831985198719891991199319951997199920012003200520072009
L
-4
G
3
In these figures K, G, L and ENC stand for capital stock, economic growth, labor force and energy consumption
respectively.
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3. Zeshan and Ahmad / Bulletin of Energy Economics, 2013, 1(2), 8-20.
Source: World Development Indicators
Decade
1970s
1980s
1990s
2000s
Table-2: Average Growth Rates
Labor Force Capital Stock Real GDP Energy Consumption
1.161
1.924
1.108
3.516
2.171
2.637
3.430
2.789
2.600
-0.663
1.405
1.476
3.378
0.320
2.254
1.052
Source: World Development Indicators and Author’s Calculations
Up to 1980, there is a weak relationship between the growth rates of energy consumption and the real
GDP which might be the result of policy inconsistency. The subsequent periods illustrate the positive
association between the two variables. Same pattern is followed between capital stock and the energy
consumption, and between labor force and energy consumption. The average growth in energy
consumption is 1.63 percent while decomposed analysis reveals that it was the highest during 1980s and
was at its minimum level during 2000s (see Figures 4-6 and Table-2 for details).
8
6
Figure-4 Real GDP and Energy Consumption
4
2
0
-2 1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009
-4
G
ENC
-6
Source: World Development Indicators
20
15
Figure-5 Capital Stock and Energy Consumption
10
5
0
-5 19711973 197519771979 198119831985 19871989 199119931995 199719992001 200320052007 2009
-10
-15
K
-20
ENC
Source: World Development Indicators
The previous discussion points out two important messages. First, there is a lack of association among
many macroeconomic variables before 1980s. Second, growth in most of the variable was at peak during
1980s. In 1970s, economist were quite uncertain about the accuracy of policy making rules, they were
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4. Zeshan and Ahmad / Bulletin of Energy Economics, 2013, 1(2), 8-20.
more concerned about the higher employment rate even if there was some rise in inflation, the so called
Phillips curve hypothesis.
10
Figure-6 Labor Force and Energy Consumption
5
0
19711973197519771979198119831985198719891991199319951997199920012003200520072009 L
-5
ENC
Source: World Development Indicators
The policy making process was much volatile as it was subject to frequent changes. Paul Volcker the
governor of Federal Reserve at that time endeavored to alter the policy objective, it initiated to target the
inflation rather than employment. This practice resulted in some problems in initial stages but later on this
policy rule brought the historical decline in inflation. The central bank of Pakistan also followed the same
inflation targeting rule now. Pakistan pursued a series of market-oriented adjustment programs to reform
its economic structure in 1980s. International financial institutions, International Monetary Fund (IMF)
and other bilateral donors, provided the sufficient resources so that Pakistan could enhance its
macroeconomic stability through the promotion of private sector and the development of export-led
industries, and improvement in the social sector indicators such as education, health, population control
measures. Mahmood et al. [14] argues that economic performance of Pakistan was quite well until 1980s,
it might be the response of the shift from the nationalization in the 1970s towards a more liberal,
deregulate and denationalized country.
II. Review of Literature
A number of studies are available on the causal relationship between the energy consumption and
economic growth in the form of country specific. For the organizational convenience, Table-3 presents
review of literature in two panels. Table-3 presents the analysis of the country specific cases as follows:
Table-3. Summary of Selected Empirical Studies
No. Author(s)
Period
Country
Methodology
Causality Direction
1
Ang [15]
1971–1999 Malaysia
Cointegration, VEC
GDP EC
2
Soytas and Sari [16]
1960–2000 Turkey
Toda–Yamamoto causality test
GDP ≠ EC
3
Ang [17]
1960–2000 France
Cointegration, VECM
EC GDP
4
Ho and Siu [18]
1966–2002 Hong Kong Cointegration, VEC
EC GDP
5
Lee [19]
1954–2003 Taiwan
Cointegration, VEC
EC GDP
6
Lee and Chang [20]
1955–2003 Taiwan
Granger causality test, Cointegration, VECM
EC GDP
7
Jobert and Karanfil [21]
1960–2003 Turkey
Granger causality test
GDP ≠EC
8
Zamani [22]
1967–2003 Iran
Granger causality test, Cointegration, VECM
GDP EC
9
Lise and Van-Montfort [23] 1970–2003 Turkey
Cointegration
GDP EC
10
Belloumi [24]
1971–2004 Tunisia
Granger causality test, VECM
EC
GDP
11
Karanfil [25]
1970–2005 Turkey
Granger causality test, Cointegration
GDP EC
12
Halicioglu [26]
1960–2005 Turkey
Granger causality test, ARDL, Co-integration
GDP ≠ EC
13
Erdal et al. [27]
1970–2006 Turkey
Granger causality test, Cointegration
EC
GDP
14
Bowden and Payne [28]
1949–2006 USA
Toda–Yamamoto causality test
EC GDP
15
Payne [29]
1949–2006 USA
Toda–Yamamoto causality test
GDP ≠ EC
16
Zhang and Cheng [30]
1960–2007 China
Granger causality test
GDP EC
Note: GDP  EC indicates causality running from economic growth to energy consumption, EC  GDP shows that energy consumption
Granger causes economic growth, EC  GDP reports the feedback effect between energy consumption and economic growth and GDP ≠ EC
means no causality is found between both variables.
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III. Methodology and Data
The SAVR is the basic tool to gauge the structural parameters in an econometric framework. The
importance of the structural estimates is evident as these estimates are the most robust in a sense that they
are not subject to Lucas critique. Sims [31] encountered the Lucas critique by assuming all variables
endogenous in the econometric model. It gave birth to reduced form VAR which could be estimated with
the help of the Ordinary Least Squares (OLS). The impulse responses (IRs) and the variance
decomposition portray the dynamic monuments of the variables in the VAR system. The estimation of the
structural VAR was used to complete in two stages. In the first stage, the reduced form VAR is estimated.
In the second stage, the parameters of the reduced form VAR are employed to construct the structural
parameters. However this practice results in identification problem, as the structural parameters are
greater in number than the reduced form parameters. This problem is solved by imposing the reasonable
restrictions on the parameters for the identification purpose. The structural parameters provide the
information that can be used in applied work and policy implications. Our basic model in simple VAR
framework is as follows:
RX t  0   1 X t 1   t
(1)
Where ' Xt ' is the vector carrying all the time series variables. ' Xt1 ' represents the matrix having the lagged
values of all the time series variables. 'R' matrix stands for the coefficients that have contemporaneous
correlation with the variables. '  0 ' and '  1 ' indicates the vector of intercepts and the matrix of the lagged
coefficient of the time series variables respectively. Finally, '  t ' stands for the vector of pure innovations,
white noised disturbances. It becomes:
X t   0  1 X t 1  et
(2)
where;
 0  R 1  0
1  R 1 1
e0  R 1  t
and
E (eit )  0
2
E (eit )  
;
(i  1,2,....n)
2
E (e1t , e1t 1 )  E (e2t , ekt1 )  0
E (e1t , e2t ) not necessarily zero.
Equation-2 specifies simple VAR in reduce form. It can be preceded further for the structural VAR. If the
right hand side of the equation yields the identical series, Ordinary Least Square (OLS) system of
equations will provide the robust results. In contrast, for any other composition of the series, it requires
 n2  n 
the Seemingly Unrelated (SUR) structure for estimation. To obtain the structural VAR, it requires the  2 
restrictions to be imposed on the system. We impose the following restrictions on the system, energy
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6. Zeshan and Ahmad / Bulletin of Energy Economics, 2013, 1(2), 8-20.
consumption cannot contemporaneously affect the real output and other factors of production, capital
stock is allowed to have a contemporaneous correlation with labor force and energy consumption and not
with real GDP, while labor force is not allowed to have a contemporaneous correlation with just the real
GDP and the capital stock. The present study employs four variables including energy consumption, real
GDP, capital stock, and labor force. It uses annual data for the period 1971-2012, all the data is in real
terms denominated in millions with 2000 as base year. The World Development Indicators and the
International Financial Statistics are the data sources.
IV. Results and their Interpretation
The SVAR impulse responses for real GDP, capital stock, labor force and the energy consumption are
denoted by D(LG), D(LK), D(LL), and D(LENC) respectively. All the impulse responses are based on
10year time horizon. All the time series are in 1st difference because they are integrated of order one as
per Schwarz Bayesian (SBC) criteria. Further, there is the absence of any cointegrating relationship
among them. A one standard deviation shock to real GDP results in the higher demand for labor force, but
this rise is not permanent in nature. It tends to converse after the period of 2 years. Same is the case with
capital stock and energy consumption. This shock also has the positive impact on capital stock and energy
consumption. Both of these variables rise because they are complements in the production process, but
this rise is also temporary in nature and both revert to their mean after the period of 2 years. One
important finding is that higher level of energy is required to facilitate the new capital stock. Hence, this
specifies the existence of growth hypothesis in Pakistan as energy consumption is expected to rise due to
rising capital stock. An unexpected rise in the capital stock results in higher real GDP growth which
persists for the near two years. This rise in real GDP is temporary and real GDP reverts back to its mean
after some time. On the other hand, there is contemporaneous rise in labor force in response to this shock.
More labor units are required to accommodate this expansion in the business and to operate the new
machines.
This rise is also temporary in nature and labor force comes back to its mean in an early period as
compared to real GDP. It specifies that labor force converges quickly as compared to real GDP. This fact
is true because of the presence of inertia in real GDP which delays its mean reversion. The mounting
capital stock also raises energy demand in the short-run. Although there is not any noticeable ascend in
the energy consumption in the initial periods but demand for energy climbs with the lag of 3 years.
Decomposing the variance in real GDP reveals a significant evidence of inertia in real GDP during the
first year. Real GDP itself is responsible for most of its variation while labor force produces around 7.8
percent variation in real GDP. After the period of 4 years, most of the variation in real GDP is brought by
labor force whereas energy consumption and capital stock are responsible for the least variation in real
GDP. Decomposing the variance in labor force reveals the presence of inertia in as most of the variation
in labor force is caused by labor force itself. Real GDP fetched the 19.6 percent variation in labor force;
capital stock carried 7.5 percent variation and energy consumption brought only 0.33 percent variation in
the Labor Force. Our results are consistent with the impulse responses, that labor force is unable to
produce any significant response in energy consumption and vice versa. The composition of variation
changes after 4 years, and capital stock and energy consumption exchange their positions. A shock to real
GDP causes most of the variation in energy consumption while labor force, energy consumption and
capital stock follow in the same sequence. Finally decomposing the variance in capital stock reveals that
most of the variation in capital stock is produced by capital stock itself while real GDP produces the
second highest; see Table-4 for details in Appendix.
V. Conclusion and Policy Implications
Across the globe, policy makers face various problems while making a national policy on energy and
same is the case in Pakistan. However, the present study endeavors to establish an empirical evidence of
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the causal relationships in energy sector of Pakistan. From 1971 to 1983, it finds deteriorating
macroeconomic conditions and lack of systematic relationship between energy consumption, GDP
growth, labor force and capital stock. However the situation becomes somehow better during the
preceding years. The present study aims to discover causal relationship among the four macroeconomic
variables in Pakistan including energy consumption, real GDP, capital stock, and labor force. It uses
annual data for the period of 1971-2012. The SVAR results reveal that economic growth increases the
demand for labor force, but this rise is not sustainable. Same is the response of capital stock and energy
consumption to such a shock. It indicates that more energy inputs are required to facilitate the new capital
stock. It is clear that the rise in energy consumption due to rising economic activity needs energy
conservation strategy in Pakistan. An exogenous shock to capital stock stimulates economic activity
temporarily. Same is the response of labor force to such a shock, rising capital stock demands more units
of labor as production activity expands in economy. The mounting capital stock also raises the energy
demand in short-run. Though the rise in energy consumption is very large, but demand for energy rises up
to the next three years.
Our results suggest that Pakistan’s production structure remains energy-intensive. The government needs
to devise means through which affordable and certain supply of power can be ensured to the various
productive sectors of the economy. Pakistan loses around PKR 150 billion per year in line losses and
power theft. A reduction in these preventable losses through prudent accountability measures can provide
some additional operating cost for generating power. A deregulated energy sector would bring more
efficiency in the energy market. There is a need to urgently attract private investment in power generation
and distribution companies. Currently the energy sector governance is very fragmented and there is
multiplicity of government departments focusing on similar issues. There are 22 government departments
implementing the power policy. Consolidating these energy departments into one single ministry or
energy authority would reduce transactions cost and facilitate greater coordination. Pakistan has the
highest reserves of coal and a potential of hydro sector to produce 60000 MW. This potential can only be
harnessed if an enabling environment is provided for the foreign investment to arrive in Pakistan.
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Appendix:
Figure-7 Response to Structural Innovation to real GDP
Response of D(LK) to Shock real GDP
.4
.3
.2
.1
.0
-.1
-.2
-.3
1
2
3
4
5
6
7
8
9
10
Response of D(LL) to Shock real GDP
.10
.05
.00
-.05
-.10
1
2
3
4
5
6
7
8
9
10
Response of D(LENC) to Shock real GDP
.15
.10
.05
.00
-.05
-.10
-.15
1
2
3
4
5
6
7
8
9
10
These Impulse Responses are based on the 10 year time horizon. The dashed red lines show the two
standard deviation error band.
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Figure-8 Response to Structural Innovation to Capital Stock
Response of D(LG) to Shock Capital Stock
.06
.04
.02
.00
-.02
-.04
-.06
-.08
1
2
3
4
5
6
7
8
9
10
Response of D(LL) to Shock Capital Stock
.06
.04
.02
.00
-.02
-.04
-.06
1
2
3
4
5
6
7
8
9
10
Response of D(LENC) to Shock Capital Stock
.08
.04
.00
-.04
-.08
-.12
1
2
3
4
5
6
7
8
9
10
These Impulse Responses are based on the 10 year time horizon. The dashed red lines show the two
standard deviation error band.
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Figure-9 Response to Structural Innovation to Labor Force
Response of D(LG) to Shock Labor Force
.12
.08
.04
.00
-.04
-.08
-.12
1
2
3
4
5
6
7
8
9
10
Response of D(LK) to Shock Labor Force
.3
.2
.1
.0
-.1
-.2
-.3
-.4
1
2
3
4
5
6
7
8
9
10
Response of D(LENC) to Shock Labor Force
.20
.15
.10
.05
.00
-.05
-.10
-.15
1
2
3
4
5
6
7
8
9
10
These Impulse Responses are based on the 10 year time horizon. The dashed red lines show the two
standard deviation error band.
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Figure-10 Response to Structural Innovation to Energy Comsumption
Response of D(LG) to Shock Energy Comsumption
.04
.00
-.04
-.08
1
2
3
4
5
6
7
8
9
10
Response of D(LK) to Shock Energy Comsumption
.3
.2
.1
.0
-.1
-.2
1
2
3
4
5
6
7
8
9
10
Response of D(LL) to Shock Energy Comsumption
.06
.04
.02
.00
-.02
-.04
-.06
1
2
3
4
5
6
7
8
9
10
These Impulse Responses are based on the 10 year time horizon. The dashed red lines show the two
standard deviation error band.
- 19 Citation: Zeshan, M., Ahmad, V. (2013). Energy Consumption and Economic Growth in Pakistan.
Bulletin of Energy Economics, 1(2), 8-20.

13. Zeshan and Ahmad / Bulletin of Energy Economics, 2013, 1(2), 8-20.
Table-4. Variance Decomposition Approach
Panel: A
Period
real GDP
Shock1
Shock2
Shock3
Shock4
Shock1
Labor Force
Shock2 Shock3
Shock4
1
100.00
0.00
0.00
0.00
9.77
5.59
84.64
0.00
2
92.11
0.01
7.88
0.00
19.67
7.56
72.44
0.33
3
54.91
5.13
14.24
25.72
25.92
6.59
66.49
1.00
4
50.10
5.15
12.89
31.87
24.08
6.95
67.95
1.01
5
31.99
4.31
38.74
24.97
22.17
6.01
59.75
12.07
Shock1-4 stands for real GDP, Capital Stock, Labor Force and Energy Consumption respectively.
Panel: B
Period
Shock1
Energy Consumption
Shock2
Shock3 Shock4
Shock1
Capital Stock
Shock2 Shock3
Shock4
1
0.20
3.92
4.45
91.43
36.57
63.43
0.00
0.00
2
40.46
1.34
38.77
19.43
52.21
45.65
0.58
1.57
3
35.47
12.27
31.61
20.65
49.24
38.17
7.84
4.75
4
34.02
10.10
26.17
29.71
48.84
36.98
9.92
4.25
5
38.36
6.04
37.64
17.96
37.19
28.49
7.12
27.19
Shock1-4 stands for real GDP, Capital Stock, Labor Force and Energy Consumption respectively.
- 20 Citation: Zeshan, M., Ahmad, V. (2013). Energy Consumption and Economic Growth in Pakistan.
Bulletin of Energy Economics, 1(2), 8-20.