ENERGY EFFICIENCY AND HUMAN ECONOMIC WELFARE

Garry Jacobs, Vice-President, The Mother’s Service Society, Pondicherry, India; Member, Board of Trustees of the World Academy of Art & Science
Ivo Šlaus,
Member, Board of Trustees and President, South East European Division of the World Academy of Art & Science

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This paper examines energy intensity as a measure of sustainability. Energy intensity is commonly measured in terms of energy consumption per unit of GDP. As an alternative, the authors propose the Fossil Fuel Energy Efficiency Index (EEI), which is designed to assess the contribution of a country’s total fossil fuel consumption to human welfare. EEI is a component of the Human Economic Welfare Index (HEWI), a composite index of economic welfare. HEWI measures human welfare by focusing on those aspects of GDP that directly relate to household consumption and savings, welfare-related government expenditure, income inequality, education and employment.

1. Measures of Sustainability

The startling findings presented in the Club of Rome’s report Limits to Growth alerted the world to the imminent danger inherent in the economic model prevalent at the time. Since then many things have changed, but the fundamental premise remains valid. A new theoretical framework is needed which recognizes environmental sustainability as an essential component of sustainable human welfare and identifies the principles by which these apparently disparate objectives can be most effectively reconciled. It is not sufficient to say that we cannot sustain current levels of resource consumption or call for a halt in economic growth. We must also take into account the impact of the change in the composition of economic activity from products to services, the impact of technological advances that develop new energy sources and increase energy efficiency, the impact of education and culture on resource consumption, the rising aspirations of the developing world, and factors influencing changes in life style, as well as the political and social sustainability. New theory means new thought, new conception. Our view of the relationship between human activity and our natural environment must change radically.

M. Max-Neff pointed out that over time more and more economic activity is self-canceling from a welfare perspective. For every society there seems to be a period in which economic growth brings an improvement in the quality of life, but only up to a point – the threshold – beyond which, if there is more economic growth, quality of life may begin to deteriorate.[1] The abrupt differences between GDP and several other indicators, e.g. energy consumption, and quality of life are similar manifestations of the Max-Neff effect.[2] Historical analyses may show that GDP was a very good indicator of economic development earlier in the last century; but today it leads to wrong conclusions and bad decisions resulting in destruction of the environment, missed opportunities and misuse of human capital.

2. Energy-Intensity and Economic Growth

The emergence of the post-industrial service economy is in the process of altering the equations concerning resource consumption, forcing us to reexamine basic postulates regarding sustainable economic growth. Services represent a non-material plane of activities to promote human welfare, while generating employment and creating money. The term service economy encompasses a very broad range of human activities, including basic research, education, health care, transport, communication, retailing, entertainment and tourism. What they have in common is a relatively lesser dependence on material resources to different degrees. The service economy still functions on the foundation of an industrial economy that requires raw materials, infrastructure, machinery and energy for service delivery, but its dependence on material resources is significantly lower in relation to GDP. Figure 1 shows the declining energy intensity in Austria, Japan and the UK over the last century as technology has become more energy efficient and the service economy has become increasingly predominant.

Figure 1: Decrease in Energy Intensity 1830–2000 [3]

In recent decades, this trend has accelerated. For example, the amount of energy needed to produce a dollar's worth of goods and services in the U.S. and U.K. declined by 40% from 1980 to 2005.[4] Between 1980 and 2005 the amount of energy needed to produce a dollar's worth of goods and services declined by 63% in China, 47% in Ireland, 40% in U.S. and U.K. In Japan, which already had very low energy intensity, it fell by another 15%. Energy and sustainability are closely related, because non-renewable fossil fuels remain the primary source of energy of production and the burning of fossil fuels is the main contributor to rising levels of the CO2 in the earth’s atmosphere. The substitution of renewable energy sources combined with continued improvements in energy efficiency have dramatically increased fossil fuel energy intensity (FFEI).

Figure 2 shows the substantial increase in FFEI (fossil fuel consumption per unit of GDP measured in 1990 international dollars) for 12 OECD countries from 1970 to 2008, a period normally denoted as the beginning of the era of the post-industrial service economy. It depicts a 64% decline in FFEI in the U.S., 62% in U.K., 58% in France, 46% in Japan. The average decline is 43%. In spite of these gains, the scope for greater global energy efficiency is still considerable. A study by McKinsey in 2008 found that a global effort to boost energy efficiency with existing technologies could eliminate more than 50% of world energy demand by 2020 and that investment in energy productivity across all major sectors generates excellent returns on investment. [5]

Figure 2: Fossil Fuel Energy Intensity for Selected OECD Countries 1970–2008. [6]

The growing emphasis on education, health and welfare is a major element of the emerging economy, as well as a central pillar in the development of human capital. The continued evolution toward a service economy based more on human capital and less on material resources does not mean that the problem of sustainable energy supplies will be solved merely by a shift in the nature of economic activity. On the contrary, advances in technology, greater public awareness and commitment, changes in public policy and changes in culture are all essential. The wholesale shift from manufacturing to services is more apparent in high income countries than in those at an earlier stage of economic development. It has long been assumed that full-scale industrialization is a necessary presage to the modern service economy and, therefore, that reduced energy intensity in the most economically advanced nations would have little impact on rising energy consumption in the developing world. The remarkable progress of countries such as India in developing highly sophisticated IT and financial sectors suggests the possibility that emerging nations may be able to leapfrog from agrarian to post-industrial economies, avoiding at least some of the excessive energy demands of industrialization. The emphasis placed on raising levels of education and increasing research is one crucial determinant of this transition.

3. Energy Intensity and Human Welfare

Many attempts have been made to incorporate measures of sustainability in composite indices. GPI and ISEW discount consumption for the depletion of or damage to environmental resources by deducting estimated costs associated with water, air and noise pollution as well as those resulting from the loss of wetlands, farmland, primary forests, CO2 damage and ozone depletion. Natural resources depletion is valued by measuring the investment necessary to generate a perpetual equivalent stream of renewable substitutes. Sen and Stigliz observed that these and similar measures such as Green GDP do not characterize ecological sustainability per se or assess how far we are from achieving sustainability targets.[7] Another composite index, the Ecological Footprint (EF), attempts to measure the impact of human activities on the regenerative capacity of the biosphere by calculating the amount of biologically productive land and water area required to support a given population at its current level of consumption and resources. EF couches the results in units of land rather than market prices. These approaches offer valuable insight into the true costs and sustainability of current economic activity. At the same time they introduce elements of complexity and subjective valuation which prevent their widespread acceptance and adoption as the basis for policy-making. They also depend on access to reliable data which is not available for most countries.

There is certainly a need for indices that assign value to natural resources and the costs associated with pollution, as well as the inherent risks and uncertainties of current economic models. While recognizing the value of these comprehensive efforts to sustainable economic activity, the authors propose a more modest and limited approach to factoring environment concerns into a composite index of economic welfare, one which can be adopted worldwide based on available data. For this purpose, we focus on a single dimension of sustainability, fossil energy efficiency.

The objective here is to measure human economic welfare rather than sound environmental practices or quality of life per se, however important these goals may be. Sustainability of economic activities is an essential aspect of economic welfare. Therefore, it is essential that it be reflected in any measure of economic welfare. The authors propose an Energy Efficiency Index (EEI) designed to promote policy-decisions that will reduce dependence on fossil fuels, while promoting improvements in the overall efficiency of all forms of energy consumption as a contribution to economic sustainability. The index takes into account only energy generated from fossil fuel sources, since fossil fuel based energy consumes non-renewable resources and releases CO2 into the atmosphere.

Some may argue that the effort to assign value to reduced dependence on fossil fuels is necessarily subjective and arbitrary, and therefore inappropriately included in a composite measure of economic welfare. This points to the underlying insufficiency of the prevailing economic concept of value. As Club of Rome member Orio Giarini has so aptly stressed, economic value in a modern service economy cannot be divorced from risk and uncertainty. No greater risk or uncertainty confronts economy today than the future risks of ecological disaster. We need only reflect on the central purpose and methods of valuation employed by the insurance industry to realize that we assign concrete economic value to risks and uncertainties all the time. That value may be related to the anticipated costs of avoidance or the costs of remediation or some less tangible value of security.

3.1 EEI: Linking Energy Efficiency to Human Welfare

In order to assess efficiency of energy usage for economic welfare rather than for economic growth, EEI is based on the ratio of fossil fuel energy consumption (FFEC) to total human economic consumption expenditure (HWE) – not to GDP. EEI is calculated as the percentage change in the ratio of fossil fuel energy consumption to HWE over time. Like education, investments in energy generation have a long gestation period, which ranges from about one year for wind turbines to 5 years or more for nuclear power, and an even longer period of utilization, which averages 30 years. Thus, each increase in the percentage of fossil fuel energy efficiency represents a long term investment in sustainability with repercussions for many years to come. Since improvements in energy efficiency can also be achieved by short term measures such as use of energy efficient lighting or refrigeration, we estimate the life span of the enhancements at a much shorter period of 10 years, though the real figure is probably much higher.

The index measures the changes in fossil fuel energy efficiency over time, where FFEC1 and FFEC0 represent fossil fuel energy consumption in year one and the previous year, and HWE1 and HWE0 represent human welfare consumption expenditure in year one and the previous year.

FFER is the ratio of fossil fuel energy consumption (FFEC) to HWE. FFERΔ1 is the change in the ratio for year one. FFERΔ-1 is the change in the ratio for the previous year. FFERΔ-2, etc. are defined analogously.

EEI for any year assigns present value (VFFER) to changes in FFER during the previous 10 years as represented by FFERΔ-1, FFERΔ-2 … FFERΔ-10. VFFER starts with a value of 1 and diminishes at the rate of 0.1 per year. Thus, VFFER-1 = 1, VFFER-2 = 0.9, VFFER-3 = 0.8, ….. VFFER-11 = 0.0.

Energy Efficiency Index EEI1 = 1 – [(VFFER-1 x FFERΔ-1) + (VFFER-2 x FFERΔ-2) +……..( VFFER-10 x FFERΔ-10)]

Energy Efficiency Index EEI1 = 1 – [(0.1 x FFERΔ-1) + (0.2 x FFERΔ-2) +…….(1.0 x FFERΔ-10)] ----------(2)

As EEI increases, the number within brackets becomes more negative in value. EEI increases either as a result of improving overall energy efficiency per unit of HWE or by replacing fossil fuel with renewable energy sources, i.e. either by decreasing FFEC or by increasing HWE.

3.2 EEI Country Comparisons

Table 1 shows fossil fuel consumption (FFEC) per unit of human consumption expenditure (HWE), FFEC as a % of total energy consumption, and the derived Energy Efficiency Index (EEI) for select countries for the year 2005. FFEC as a % of total energy consumption indicates the extent of dependence on fossil fuel energy sources vs. renewable energy sources, which ranges from a low of 37% in Sweden to a high of 93% in China.[8] FFEC per unit of HWE (in constant 2005 intl dollars) ranges from a low of 4683 Btu per dollar in Sweden to a high of 28, 181 Btu per dollar in China in 2005, a factor of 6.0. About 60% of this difference is the result of Sweden’s lower dependence on fossil fuel energy sources in comparison to China. The remainder of the difference is due to Sweden’s higher overall energy efficiency.

EEI measures the change in the FFEC/HWE ratio between 1995 and 2005. Values greater than 1.0 indicate decreasing use of fossil fuels and/or increasing HWE. While China’s FFEC rose by 90% during this period due to a huge expansion of manufacturing capacity, HWE rose 104%, resulting in an EEI of 1.04. Russia’s FFEC rose only 5% during the same period, while its HWE rose by 54%, resulting in an EEI of 1.05. The full benefits of these improvements will only be reflected by 2015. We were unable to include historical data for Russia in Table 2 due to the absence of reliable data during the period immediately prior to and subsequent to the breakup of the USSR. Thus, data on Russia’s EEI for the period 1995-2005 must be taken with caution.

Table 1: Energy Intensity, Fossil fuel consumption (FFEC) per unit of human consumption expenditure (HWE), FFEC as a % of total energy consumption, and the derived Energy Intensity Index (EEI) for select countries. FFEC is in BTU per dollar. HWE is in constant$ 2005 PPP. Values are calculated for year 2005.

India’s FFEC rose by 42% while its HWE rose by 72%, resulting in an EEI of 1.06. Spain’s FFEC rose 54% while its HWE rose only 46%, resulting in a decline in overall fossil fuel energy efficiency as reflected by an EEI of 0.94. Of the countries studied, the only other one to report a decline in energy efficiency was Brazil with an EEI of 0.98.[9] Three countries – USA, UK and Sweden – registered EEIs of more than 1.10.

Table 2 presents historical data on changes in fossil fuel energy consumption per unit of human consumption expenditure from 1975 to 2005. It also shows the historical values for EEI from 1985 to 2005 and a 30 year average of the change in FFEC/HWE (EEI30). Of the nine countries studied, only Korea and India recorded a decline in fossil fuel energy efficiency over the period 1975-2005, as reflected in EEI30 values of less than 1.00. China registered the largest improvement over the 30 year period (65%), followed by Sweden (63%), UK (57%) and USA (56%).

Table 2: Trends in Energy Efficiency Index (EEI) from 1985 to 2005 for select countries. FFEC/HWE is in BTU per dollar.

Table 3 presents EEI for select countries in 2008. EEI values greater than 1 indicate decreasing consumption of fossil fuel or increasing HWE. Fossil Fuel Consumption in Russia has decreased by 47% and 31% in Sweden in ten years; while in Brazil and Japan, it has gone down by just 1% and 2% during the same period. Though Korea has had only a 14% decrease in fossil fuel energy consumption, its HWE has seen a 63% increase, which explains the reason for Korea’s leading score on the EEI.

Table 3: Fossil Fuel Energy Consumption per consumption expenditure for the years 1998 and 2008 and Human Energy Efficiency Index (EEI) for the year 2008

4. The HEWI Composite Index


Figure 3: Dimensions of sustainable economic welfare

HEWI is based on a broad conception of sustainability that incorporates economic, ecological and social factors. It is structured to give balanced weightage to current and future welfare. In addition to measuring personal disposable income and welfare-related consumption, it monitors two negative components that limit present welfare – income inequality and unemployment – and three positive components that have the potential to significantly enhance long term sustainability –education, energy efficiency and net household savings. Income inequality is viewed as a constraint on growth of consumer demand, which limits present consumption and employment. Unemployment is viewed as a constraint on the full utilization of human resources and social productivity, which limits the economic welfare of both the unemployed and the rest of society. Rising levels of education are viewed as an investment in human capital that promotes future economic welfare. Rising levels of fossil fuel energy efficiency are viewed as an investment in physical capital that supports future ecological welfare. Net household savings provides the financial basis for future investment and human welfare consumption.

HEWI has seven sub-indices that reflect social and economic welfare of the society. [10] The correlation between the individual sub-indices and welfare can be analyzed by studying the individual components which are briefly described below.

4.1 Human Welfare Government Expenditure (HWGE)

The government expenditure component (HWGE) is a subset of GDP that directly relates to human welfare. It includes public expenditure on Environment, Education, Health, Housing and Social Protection and omits outlays for defense and general administration.

4.2 Personal Disposable Income (PDI)

GDP measures national income rather than disposable income at the household level. It does not discriminate between economies whose consumption is based on rising levels of debt and those which are accumulating savings for investment or future consumption. The Net Household Savings (NHS) component of HEWI measures both personal consumption and savings to arrive at a composite figure for personal disposable income.

4.3 Economic Welfare Index (EWI)

The impact of income inequality on the economic welfare of the society is accounted for by adjusting the Personal Disposable Income based on the Gini coefficient. The objective here is not to measure Income Inequality per se, but rather to assess the impact of income inequality on overall levels of human economic welfare. The Economic Welfare Index is a variant of Amartya Sen’s “Social Welfare Function”.

4.4 Full Employment Index (FEI)

Full Employment Index is a composite measure of employment security that takes into account the population-to-employment ratio (age 25+), youth employment, adult employment, and job creation. This modified version of HEWI also includes a measure of the long term employment rate. FEI is an average of these five sub-indices which provides a more detailed and reliable picture of the utilization of human capital and the prospects for income security among different age groups than a single-measure index such as the unemployment rate.

4.5 Combined Education Index (CEI)

The Combined Education Index treats rising levels of education as an investment in future economic welfare and adjusts present GDP to reflect the present value of these investments. CEI takes into account enrollment rates in the primary, secondary and tertiary levels based on normalized UNDP Combined Gross Enrollment rates (CGER). In view of the higher importance of tertiary education in economic development, double weightage is assigned to the tertiary enrollment. The index is also adjusted to reflect differences in educational quality based on PISA (Programme for International Student Assessment), a standard international measure adopted by the OECD and other countries.

4.6 Energy Efficiency Index (EEI)

The Energy Efficiency Index measures the relationship between human economic welfare and environmental sustainability. It monitors changes in the level of dependence on fossil fuels as well as overall energy efficiency per unit of human-welfare related expenditure. Improvements in fossil fuel energy efficiency per unit of human-welfare expenditure are regarded as a reflection of investment in a more sustainable future.

4.7 Health Adjusted Life Expectancy Index (HALE Index)

Average life expectancy provides relevant information about overall human welfare, but it does not take into account the impact of disabilities and illness on quality of life among the elderly. The Health Adjusted Life Expectancy Index measures healthy longevity for those aged 60 and above, excluding the effects of disabilities and other health issues.

4.8 Human Economic Welfare Index (HEWI)

USA ranks first in the Human Economic Welfare Index though the economic welfare reach is just 42% of the country’s GDP. 75% of Russia’s GDP is welfare oriented even when it has taken the eighth position. Brazil’s HEWI is just 17% of the GDP and almost 5 times Brazil’s GDP/c is the United States’.

Table 4: All sub-indices of HEWI and HEWI as % of GDP for 2005

In terms of GDP/c, USA is 28% higher than the second-ranked Germany but in the case of HEWI, the USA’s HEWI is just 1% higher than Germany. For a detailed discussion of HEWI and its subcomponents, see Human Economic Welfare Index Project. [11]

Notes


[1] Manfred Max-Neff, “Economic growth and quality of life: a threshold hypothesis,” Ecological Economics, 15(1995): 115-118.

[2] Will Wilkinson, “In Pursuit of Happiness Research. Is it Reliable? What does it imply for Policy?” The Cato institute, April 2007, Vergata Conference on Subjective Well-Being.

[3] Marina Fischer-Kowalski and Helga Weisz, “Transition to a Globally Sustainable Metabolism—Possible and Impossible Futures” Presented at the 2008 Conference of the International Society for Ecological Economics, Nairobi, Kenya, August 2008; p. 7.

[4] U.S. Department of Energy, Energy Intensity Indicators in the U.S., Energy Efficiency & Renewable Energy, 2008. http://www1.eere.energy.gov/ba/pba/intensityindicators/total_energy.html

[5] Ernst Von Weizsaecker et al., Factor Five: Transforming the Global Economy Through 80% Improvements in Resource Productivity (London, UK: Earthscan, 2009), 38.

[6] U.S. Energy Information Administration. International Energy Annual 2006. http://www.eia.doe.gov/iea/

[7] Joseph Stiglitz. Amartya Sen and Jean-Paul Fitoussi, Report by the Commission on the Measurement of Economic Performance and Social Progess, 2009.

[8] Historical Data on Fossil fuel consumption values, British Petroleum http://www.bp.com/liveassets/bp_internet/globalbp/globalbp_uk_english/re...

[9] Saraswathi Mukkai and Ranjani Ravi, “Research Methodology and Data for a Fossil Fuel Energy Index” MSS Research Working Paper, The Mother’s Service Society, September 2010. http://mssresearch.org/?q=Research_Methodology_and_Data_for_a_Fossil_Fuel_Energy_Index.

[10] Garry Jacobs and Ivo Šlaus, “Indicators of Economic Progress: The Power of Measurement and Human Welfare,” Cadmus 1, no. 1 (2010): 53-113.

[11] Human Economic Welfare Index Project, The Mother’s Service Society http://mssresearch.org/?q=node/576

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