Complementary inputs and industrial development: can lower electricity prices improve energy efficiency?

The transition from traditional labour-intensive to modern capital-intensive production is a key factor for industrial development. Electricity is critical to most modern manufacturing, and low electricity prices can therefore play a key role in incentivising countries and sectors to upgrade to modern capital-intensive and electricity-based production. At the same time, there is large and rapidly growing demand for energy coming from industrial sectors, particularly in low- and middle-income countries. While countries struggle to meet their Paris Agreement targets for emissions, energy efficiency is often the principal way to reduce industrial emissions, but here we usually think of higher, not lower, electricity prices helping in the process.

In this paper, the author argues that, in some contexts, there may not be such a trade-off between developmental and environmental goals. Specifically, using data from Indian factories and econometric techniques that isolate exogenous variation in prices, the author shows that lower industrial electricity prices can improve not only labour productivity but, surprisingly, also electricity productivity (that is, output per unit of electricity). Apart from positive effects on firm economic and environmental performance, consumers significantly benefit from lower output prices through cost-price pass-through, and the productivity improvements from lower electricity prices limit rises in carbon emissions by a large margin.

Key points for decision-makers

• This paper shows that lower electricity prices can serve both environmental and developmental goals by improving electricity productivity and labour productivity in firms.
• The benefits of lower industrial electricity prices not only accrue to firms: cost savings are passed through to consumers, resulting in significant welfare benefits.
• While total carbon emissions increase from the scaling up of industry, the boost in electricity productivity attenuates the additional emissions from scaling up by more than half.
• The causal estimates from the micro data help explain puzzling trends at the aggregate level of falling industrial electricity prices and concurrent rising electricity productivity.
• The context of industrial development is important: the paper shows that this comes from upgrading to modern machine-intensive production that requires electricity, which can boost output more than electricity consumption.
• While these effects are unlikely to apply in the same manner in highly industrialised countries that already produce using modern electricity-based machinery, the findings are more broadly relevant for many countries for incentivising transitions to electricity in residential heating, transport or industry through lower electricity prices.