Explaining Factors Affecting Energy Demand Elasticity: Does the Quality of Institutions Matter?

Abstract

Up to the present time energy intensity of production in the former socialist countries is essentially higher than in the countries with sound market economy. So, in CIS economies energy consumption per a unit of GDP is 3 to 4 times as high as that in OECD Europe countries. We suggest and show using econometric model that severe climatic conditions explain this difference only partly. A model of energy consuming production sector is suggested all the firms holding market power and facing uncertain transaction cost at the market. We show that given an energy price shock the higher is probability to encounter the high transaction cost, the less the number of the firms, which implement energy saving projects is. A cross country econometric analysis involving also a climatic variable, a shadow economy size variable, and an institutional component based on 2000 international statistical data suggests that energy price elasticity of energy intensity parameter is the lower (by its absolute value) the weaker is institutional environment in a given economy. We provide estimation results of these coefficients by 74 economies as well. From six institutional indices provided by the World Bank database "Governance Matters V: Governance Indicators for 1996-2005” two ones - Government Effectiveness and Graft – have the highest significance in the model. This fact confirms a certain idea that corruption is the main obstacle negatively affecting operation of economic mechanisms in the most of the transitional economies.