From theory to econometrics to energy policy: Cautionary tales for policymaking using aggregate production functions

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  • Matthew K. Heun
  • João Santos
  • Paul E. Brockway
  • Randall Pruim
  • Tiago Domingos
  • Marco Sakai


Publication details

DateAccepted/In press - 24 Jan 2017
DatePublished (current) - 10 Feb 2017
Issue number2
Number of pages24
Pages (from-to)1-24
Original languageEnglish


Development of energy policy is often informed by economic considerations via aggregate production functions (APFs). We identify a theory-to-policy process involving APFs comprised of six steps: (1) selecting a theoretical energy-economy framework; (2) formulating modeling approaches; (3) econometrically fitting an APF to historical economic and energy data; (4) comparing and evaluating modeling approaches; (5) interpreting the economy; and (6) formulating energy and economic policy. We find that choices made in Steps 1-4 can lead to very different interpretations of the economy (Step 5) and policies (Step 6). To investigate these effects, we use empirical data (Portugal and UK) and the Constant Elasticity of Substitution (CES) APF to evaluate four modeling choices: (a) rejecting (or not) the cost-share principle; (b) including (or not) energy; (c) quality-adjusting (or not) factors of production; and (d) CES nesting structure. Thereafter, we discuss two revealing examples for which different upstream modeling choices lead to very different policies. In the first example, the (kl)e nesting structure implies significant investment in energy, while other nesting structures suggest otherwise. In the second example, unadjusted factors of production suggest balanced investment in labor and energy, while quality-adjusting suggests significant investment in labor over energy. Divergent outcomes provide cautionary tales for policymakers: greater understanding of upstream modeling choices and their downstream implications is needed.

Bibliographical note

© 2017 by the authors; licensee MDPI, Basel, Switzerland.

    Research areas

  • CES, Cost share principle, Econometrics, Energy policy, Solow residual

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