## introduction of a carbon tax and the removal of fossil fuel subsidies, are critical for energy ## Source details **Canonical URL:** [introduction of a carbon tax and the removal of fossil fuel subsidies, are critical for energy](https://www.imf.org/-/media/files/publications/wp/2023/english/wpiea2023198-print-pdf.pdf) ## Other formats - [Markdown version](/-/media/files/publications/wp/2023/english/wpiea2023198-print-pdf.pdf.md) - [Structured JSON version](/-/media/files/publications/wp/2023/english/wpiea2023198-print-pdf.pdf.json) --- ### Key findings - Price signals, including through the introduction of a carbon tax and the removal of fossil fuel subsidies, are critical for energy efficiency because consumers respond to changes in energy prices. - Higher energy costs have a statistically and economically significant effect that incentivizes investments and behavioral changes to become more energy efficient. - Stronger environmental policies and institutions, as measured by the Environmental Policy Stringency (EPS) index and a composite index of bureaucratic quality, generate unambiguous improvements in energy efficiency by inducing investment in energy efficient equipment and buildings and nudging consumers for energy conservation. - Economic globalization enhances energy efficiency through technological progress, innovations, and carbon leakage via international trade, which dampen energy consumption by firms and households. - Demographic influences are opposing: - Higher population density helps increase energy efficiency by inducing economies of scale. - Urbanization places greater strains on energy resources and lowers efficiency. - Human capital matters: a higher share of population with tertiary education is associated with lower total energy consumption per capita or per unit of GDP. ### Data overview - Sample: unbalanced panel of annual observations for 38 countries in Europe during the period 1980–2021. - Dependent variables: - Energy efficiency (intensity) measured by total energy consumption per unit of GDP. - Robustness check: total energy consumption per capita. - Energy consumption definitions: - Total energy consumption per capita = total energy consumption in Btu divided by population for each country and year. - Total energy consumption per unit of GDP = total energy consumption in Btu for each country and year divided by GDP using purchasing power parities in billions of (2015) U.S. dollars. - Total energy consumption includes: consumption of petroleum, dry natural gas, coal, net nuclear, hydroelectric, and non-hydroelectric renewable electricity, as well as net electricity imports (electricity imports – electricity exports) and net coke imports (coke imports – coke exports). - Explanatory variables selected: (i) real GDP per capita; (ii) share of industry and services in total value-added; (iii) trade openness (sum of exports and imports in GDP); (iv) energy price index in real terms (EIA); (v) population and share of urban population; (vi) educational attainments (share with tertiary education); (vii) EPS index (OECD); (viii) composite measure of institutional quality. - Data sources: US Energy Information Agency (EIA), World Bank, OECD, UNCTAD, International Country Risk Guide (ICRG). ### Empirical strategy - Methodology: stochastic frontier analysis (SFA) in a cross-country panel, augmenting models used in Filipini and Hunt (2012) and Belotti et al. (2013). - Functional form: log–log specification linking energy efficiency (EE) to GDP per capita, industry share (IND), services share (SER), openness (OPN), energy price index (EPI), population (POP), urbanization (URB), education (EDU), EPS, and institutional quality (INS). - Error decomposition: εit = νit − uit, with νit ~ normal (random noise) and uit (inefficiency) non-negative, assumed exponential. - Technical efficiency score: EFit = EEit / EEitF = exp(−ui t). - Estimation approaches: True Fixed Effect (TFE) baseline and True Random Effect (TRE) for robustness; time-invariant and time-varying models as additional robustness checks. ### Empirical results and key elasticities - Energy price effects: - A one percent increase in energy prices in real terms is associated with a decline of 0.03 to 0.09 percent in total energy consumption per unit of GDP. - A one percent increase in energy prices is associated with a decline of 0.09 to 0.10 percent in total energy consumption per capita. - Environmental policy (EPS) effects: - A one percent increase in the EPS leads to a decline of 0.03 to 0.05 percent in total energy consumption per unit of GDP. - EPS effect on total energy consumption per capita: about 0.03 percent decline. - Using EPS restricted to “market-based policies” yields broadly similar results and a more pronounced impact when focusing on climate change-related environmental policies. - Institutional quality (bureaucratic quality) effects: - A one percent increase in bureaucratic quality leads to a decline of 0.03 percent in total energy consumption per unit of GDP. - For energy consumption per capita, the decline is 0.01 to 0.03 percent. - Real GDP per capita: - Elasticity of total energy consumption per unit of GDP with respect to real GDP per capita is negative within the range of -0.67 to -0.35 percent. - For energy consumption per capita, the relationship is positive, with estimated coefficients in the range of 0.32 to 0.35 percent. - Sectoral structure: - Industrial activity is associated with higher energy consumption (energy-intensive production). - Services contribute to higher energy consumption per unit of GDP (or per capita), albeit at a lower rate compared to industry. - Trade openness: - Trade openness coefficient is not large in magnitude but statistically significant across all specifications; interpreted as capturing technological progress, innovations, and carbon leakage effects. - Demographics: - Population: a one percent increase in population is associated with a decline of 0.17 to 0.28 percent in total energy consumption per unit of GDP (or 0.16 to 0.31 percent in total energy consumption per capita). - Urbanization: a one percent increase in urbanization is associated with an increase of 0.35 percent in total energy consumption per unit of GDP (or 0.37 to 0.76 percent in total energy consumption per capita). - Human capital: - A one percent increase in the share of population with tertiary education leads to a decline of about 0.01 percent in total energy consumption per unit of GDP (or per capita). ### Magnitude, robustness, and interpretation - The average level of energy efficiency in Europe remains about 10 percent below the frontier. - On average, European countries are operating at about 90 percent of the efficiency frontier, with significant variation across countries. - Although raising the level of energy efficiency by 10 percent would not be enough to bring down GHG emissions towards the net-zero target by 2050, it would still make a significant contribution. - The finding of average energy efficiency in Europe is consistent with other studies, such as Kraiche, Kutlu, and Mao (2022) who found an average energy efficiency of about 92 percent in Europe during the period 1990-2015. ### Determinants and quantitative indicators (select) - Environmental policy stringency has a statistically significant relationship with energy efficiency (coefficients reported in Appendix Table A4 for alternate specifications are negative and significant at conventional levels). - Real GDP per capita, share of industry in GDP, share of services in GDP, trade openness, energy price, population, urbanization, educational attainments, bureaucratic quality are included as determinants in regression specifications (see Appendix Table A4). - Fossil fuel subsidies in Europe: explicit and implicit subsidies account for 16 percent of explicit and 11 percent of explicit and implicit subsidies worldwide after a 300 percent increase during the recent surge in energy prices caused by Russia’s invasion of Ukraine. - Total subsidies in Europe amount to about 3 percent of GDP, compared to 10 percent in Asia and Pacific, 18 percent in the Middle East and North Africa, and 23 percent in the Commonwealth of Independent States. ### Policy implications and recommendations - Use price signals: - Introduce carbon taxes and remove fossil fuel subsidies to raise real energy prices, thereby incentivizing investments and lifestyle changes that improve energy efficiency. - Recognize the role of carbon pricing policies such as national carbon taxes and the European Union’s Emission Trading System (EU ETS) in climate change mitigation. - Strengthen environmental policy and institutions: - Increase Environmental Policy Stringency (EPS) to induce investment in energy efficient equipment and buildings and to nudge consumer conservation behavior. - Improve bureaucratic quality to provide a more conducive investment environment and advance behavioral changes that raise energy efficiency. - Promote human capital accumulation: - Expand advanced education to encourage energy-efficient household choices and to catalyze technology and productivity gains that lower energy consumption per unit of GDP. - Sectoral and structural focus: - Increase energy efficiency across all sectors, including fast-growing services, and expand renewable energy generation to reduce dependency on imported energy and lower GHG emissions in line with net-zero targets. - Complementary reforms: - Combine decarbonizing the energy mix (lower GHG emissions per unit of energy) with measures to boost energy efficiency (lower energy consumption per unit of GDP or per capita) to achieve net zero by 2050 while sustaining economic well-being. *Italic: IMF Working Paper (wpiea2023198) chapter/section: introduction of a carbon tax and the removal of fossil fuel subsidies, are critical for energy* ### introduction of a carbon tax and the removal of fossil fuel subsidies, are critical for energy ### introduction of a carbon tax and the removal of fossil fuel subsidies, are critical for energy ### Key findings - Price signals, including through the introduction of a carbon tax and the removal of fossil fuel subsidies, are critical for energy efficiency because consumers respond to changes in energy prices. - Higher energy costs have a statistically and economically significant effect that incentivizes investments and behavioral changes to become more energy efficient. - Stronger environmental policies and institutions, as measured by the Environmental Policy Stringency (EPS) index and a composite index of bureaucratic quality, generate unambiguous improvements in energy efficiency by inducing investment in energy efficient equipment and buildings and nudging consumers for energy conservation. - Economic globalization enhances energy efficiency through technological progress, innovations, and carbon leakage via international trade, which dampen energy consumption by firms and households. - Demographic influences are opposing: - Higher population density helps increase energy efficiency by inducing economies of scale. - Urbanization places greater strains on energy resources and lowers efficiency. - Human capital matters: a higher share of population with tertiary education is associated with lower total energy consumption per capita or per unit of GDP. ### Data overview - Sample: unbalanced panel of annual observations for 38 countries in Europe during the period 1980–2021. - Dependent variables: - Energy efficiency (intensity) measured by total energy consumption per unit of GDP. - Robustness check: total energy consumption per capita. - Energy consumption definitions: - Total energy consumption per capita = total energy consumption in Btu divided by population for each country and year. - Total energy consumption per unit of GDP = total energy consumption in Btu for each country and year divided by GDP using purchasing power parities in billions of (2015) U.S. dollars. - Total energy consumption includes: consumption of petroleum, dry natural gas, coal, net nuclear, hydroelectric, and non-hydroelectric renewable electricity, as well as net electricity imports (electricity imports – electricity exports) and net coke imports (coke imports – coke exports). - Explanatory variables selected: (i) real GDP per capita; (ii) share of industry and services in total value-added; (iii) trade openness (sum of exports and imports in GDP); (iv) energy price index in real terms (EIA); (v) population and share of urban population; (vi) educational attainments (share with tertiary education); (vii) EPS index (OECD); (viii) composite measure of institutional quality. - Data sources: US Energy Information Agency (EIA), World Bank, OECD, UNCTAD, International Country Risk Guide (ICRG). ### Empirical strategy - Methodology: stochastic frontier analysis (SFA) in a cross-country panel, augmenting models used in Filipini and Hunt (2012) and Belotti et al. (2013). - Functional form: log–log specification linking energy efficiency (EE) to GDP per capita, industry share (IND), services share (SER), openness (OPN), energy price index (EPI), population (POP), urbanization (URB), education (EDU), EPS, and institutional quality (INS). - Error decomposition: εit = νit − uit, with νit ~ normal (random noise) and uit (inefficiency) non-negative, assumed exponential. - Technical efficiency score: EFit = EEit / EEitF = exp(−ui t). - Estimation approaches: True Fixed Effect (TFE) baseline and True Random Effect (TRE) for robustness; time-invariant and time-varying models as additional robustness checks. ### Empirical results and key elasticities - Energy price effects: - A one percent increase in energy prices in real terms is associated with a decline of 0.03 to 0.09 percent in total energy consumption per unit of GDP. - A one percent increase in energy prices is associated with a decline of 0.09 to 0.10 percent in total energy consumption per capita. - Environmental policy (EPS) effects: - A one percent increase in the EPS leads to a decline of 0.03 to 0.05 percent in total energy consumption per unit of GDP. - EPS effect on total energy consumption per capita: about 0.03 percent decline. - Using EPS restricted to “market-based policies” yields broadly similar results and a more pronounced impact when focusing on climate change-related environmental policies. - Institutional quality (bureaucratic quality) effects: - A one percent increase in bureaucratic quality leads to a decline of 0.03 percent in total energy consumption per unit of GDP. - For energy consumption per capita, the decline is 0.01 to 0.03 percent. - Real GDP per capita: - Elasticity of total energy consumption per unit of GDP with respect to real GDP per capita is negative within the range of -0.67 to -0.35 percent (higher economic development associated with higher energy efficiency by this measure). - For energy consumption per capita, the relationship is positive, with estimated coefficients in the range of 0.32 to 0.35 percent. - Sectoral structure: - Industrial activity is associated with higher energy consumption (energy-intensive production). - Services contribute to higher energy consumption per unit of GDP (or per capita), albeit at a lower rate compared to industry. - Trade openness: - Trade openness coefficient is not large in magnitude but statistically significant across all specifications; interpreted as capturing technological progress, innovations, and carbon leakage effects. - Demographics: - Population: a one percent increase in population is associated with a decline of 0.17 to 0.28 percent in total energy consumption per unit of GDP (or 0.16 to 0.31 percent in total energy consumption per capita). - Urbanization: a one percent increase in urbanization is associated with an increase of 0.35 percent in total energy consumption per unit of GDP (or 0.37 to 0.76 percent in total energy consumption per capita). - Human capital: - A one percent increase in the share of population with tertiary education leads to a decline of about 0.01 percent in total energy consumption per unit of GDP (or per capita). ### Policy implications and recommendations - Use price signals: - Introduce carbon taxes and remove fossil fuel subsidies to raise real energy prices, thereby incentivizing investments and lifestyle changes that improve energy efficiency. - Recognize the role of carbon pricing policies such as national carbon taxes and the European Union’s Emission Trading System (EU ETS) in climate change mitigation. - Strengthen environmental policy and institutions: - Increase Environmental Policy Stringency (EPS) to induce investment in energy efficient equipment and buildings and to nudge consumer conservation behavior. - Improve bureaucratic quality to provide a more conducive investment environment and advance behavioral changes that raise energy efficiency. - Promote human capital accumulation: - Expand advanced education to encourage energy-efficient household choices and to catalyze technology and productivity gains that lower energy consumption per unit of GDP. - Sectoral and structural focus: - Increase energy efficiency across all sectors, including fast-growing services, and expand renewable energy generation to reduce dependency on imported energy and lower GHG emissions in line with net-zero targets. - Complementary reforms: - Combine decarbonizing the energy mix (lower GHG emissions per unit of energy) with measures to boost energy efficiency (lower energy consumption per unit of GDP or per capita) to achieve net zero by 2050 while sustaining economic well-being. ### Conclusion - Global context: average surface global temperature is about 1.1°C warmer compared with the preindustrial average; limiting warming to 1.5°C requires halving GHG emissions by 2030 and bringing them to zero by 2050. - Fossil fuels currently generate about 80 percent of global energy needs and account for more than two-thirds of GHG emissions. - Rapid transition to renewables is needed but must be managed to avoid undermining energy system stability and causing socioeconomic hardship. - Empirical assessment for 38 European countries (1980–2021) using SFA highlights: - Price signals (carbon tax, removal of subsidies) and stronger environmental policies and institutions are key levers to raise energy efficiency. - Policy packages combining carbon pricing, strengthened environmental policy, improved governance, human capital accumulation, sectoral efficiency improvements, and renewable expansion can reduce dependency on imported energy, lower GHG emissions in line with net-zero targets, and deliver green growth. *Italic: IMF Working Paper (wpiea2023198) chapter/section: introduction of a carbon tax and the removal of fossil fuel subsidies, are critical for energy* ### introduction of environmental policies and institutional quality, which provide more information ### wpiea2023198-print-pdf - introduction of environmental policies and institutional quality, which provide more information ### Key empirical findings - Stronger environmental policies and institutions generate unambiguous improvements in energy efficiency by inducing investment in energy efficient equipment and buildings and nudging consumers for energy conservation. - Real GDP per capita is associated with higher energy efficiency when it is measured by total energy consumption per unit of GDP, which better captures the differences in economic development and advancements in infrastructure and technology. - The structure of the economy exhibits a positive relationship with both measures of energy consumption: industry has seen reduced energy intensity over time through technological advancements, while services (including transportation and communication) contribute to lower levels of energy efficiency. - Economic globalization helps enhance higher energy efficiency through technological progress and innovations and carbon leakage through international trade, which dampen energy consumption by firms and households. - Price signals, including through the introduction of a carbon tax and the removal of fossil fuel subsidies, are important in incentivizing investments to become more energy efficient. - Higher population density helps increase energy efficiency by inducing economies of scale, while urbanization places greater strains on energy resources and thereby lowers the level of efficiency. - Human capital (measured by educational attainments) contributes to more energy efficient choices at the micro level and has catalytic effects on technology and productivity at the macro level. ### Magnitude, robustness, and interpretation - Empirical findings based on the SFA—robust to different specifications and estimation methodologies—indicate that the average level of energy efficiency in Europe remains about 10 percent below the frontier. - This implies that, on average, European countries are operating at about 90 percent of the efficiency frontier, with significant variation across countries. - Although raising the level of energy efficiency by 10 percent would not be enough to bring down GHG emissions towards the net-zero target by 2050, it would still make a significant contribution. - The finding of average energy efficiency in Europe is consistent with other studies, such as Kraiche, Kutlu, and Mao (2022) who found an average energy efficiency of about 92 percent in Europe during the period 1990-2015. ### Determinants and quantitative indicators (select) - Environmental policy stringency has a statistically significant relationship with energy efficiency (coefficients reported in Appendix Table A4 for alternate specifications are negative and significant at conventional levels). - Real GDP per capita, share of industry in GDP, share of services in GDP, trade openness, energy price, population, urbanization, educational attainments, bureaucratic quality are included as determinants in regression specifications (see Appendix Table A4). - Fossil fuel subsidies in Europe: explicit and implicit subsidies account for 16 percent of explicit and 11 percent of explicit and implicit subsidies worldwide after a 300 percent increase during the recent surge in energy prices caused by Russia’s invasion of Ukraine. - Total subsidies in Europe amount to about 3 percent of GDP, compared to 10 percent in Asia and Pacific, 18 percent in the Middle East and North Africa, and 23 percent in the Commonwealth of Independent States. ### Policy implications and recommendations - Raise economic growth, strengthen trade integration, and promote the accumulation of human capital through advanced education to contribute to greater energy efficiency gains. - Strengthen environmental policies and good governance to build a conducive investment environment and foster behavioral change across society. - Design structural reforms in the energy sector not just for market efficiency but also for environmentally sustainable growth that delivers higher productivity and lower GHG emissions. - Increase energy efficiency in all sectors (including fast-growing services) and expand renewable energy generation to reduce Europe’s dependency on imported sources of energy and help reduce GHG emissions in line with the net-zero target while delivering green growth. - Use price signals—such as carbon pricing and removal of fossil fuel subsidies—to incentivize energy-efficiency investments. ### Appendices and sample coverage - Appendix Table A1. Descriptive Statistics. - Appendix Table A2. List of Countries in the Sample includes: Albania; Austria; Belgium; Bosnia and Herzegovina; Bulgaria; Croatia; Cyprus; Czechia; Denmark; Estonia; Finland; France; Germany; Greece; Hungary; Iceland; Ireland; Italy; Kosovo; Latvia; Lithuania; Luxembourg; Malta; Montenegro; Netherlands; North Macedonia; Norway; Poland; Portugal; Romania; Serbia; Slovakia; Slovenia; Spain; Sweden; Switzerland; Turkey; United Kingdom. - Appendix Table A3–A5 present alternate measures, alternative EPS specifications, and robustness checks; Appendix Table A4 reports detailed regression coefficients and standard errors for TFE and TRE specifications across 517 observations and 38 countries with country and time fixed effects. *Source: Authors’ estimations, wpiea2023198-print-pdf - introduction of environmental policies and institutional quality, which provide more information.* --- _Source: https://www.imf.org/-/media/files/publications/wp/2023/english/wpiea2023198-print-pdf.pdf_