Umar Farooq
By Umar Farooq, Assistant Professor of Economics and International Business at Birla Institute of Management Technology (BIMTECH), Greater Noida
The role of energy in economic development is well-documented in the empirical literature (Dogan et al., 2020; Amin et al., 2020; Joseph and Charles, 2021). No country can envision the prosperity and upliftment of its people without enough access to prospective energy sources. An adequate supply of energy is critical for promoting economic growth, improving health and education, and establishing a more competitive job market (Ouedraogo 2013; Wang et al., 2018). A substantial body of literature has been devoted to studying the drivers of energy consumption (Rafindadi and Ozturk, 2017; Shastri et al., 2020). Among the key variables used to estimate energy demand are financial development (Anton & Afloarei Nucu, 2020; Yi et al., 2023), geopolitical uncertainty (Cai & Wu, 2021), per capita GDP (Bui Minh & Bui Van, 2023), and trade openness (Murshed, 2020). Various reasons have been proposed to establish the theoretical linkage between energy consumption and these variables.
The relationship between financial development and energy consumption has been extensively studied Khan et al., 2020, Mahalik et al., 2017). According to Sadorsky (2010), financial development encourages capital inflows and production activities. A developed financial sector stimulates more start-ups, expansions and innovations. By offering low-cost loans, financial institutions promote increased industrial activities, which are heavily reliant on energy inputs; hence, energy consumption escalates. Moreover, a developed financial sector also stimulates additional R&D activities and the adoption of energy-efficient technologies, which eventually reduce energy consumption (Yang et al., 2020). Putting in other way, the relationship is indeed complex and vary depending on the level of financial development (Ahmed, 2017). In the initial stages of financial development, increased access to capital often leads to higher industrial activity and, consequently, greater energy consumption. However, as the financial sector matures, it facilitates investments in R&D and the adoption of energy-efficient technologies, which could lead to a reduction in energy consumption over time.
Geopolitical uncertainty, which includes uncertainties associated with war and terror threats, as well as military and nuclear-related tensions, affects domestic and international tourism, economic growth, research and development activities, and energy consumption (Pan, 2018; Alola et al., 2019; Rasoulinezhad et al., 2020). Geopolitical uncertainties can impact energy demand both positively and negatively. On one hand, by reducing energy consumption, geopolitical uncertainty discourages spending and investment decisions, curbs domestic and international tourism, and reduces foreign direct investment. On the other hand, war and terror-related events may prompt a country to accumulate energy reserves for potential use in conflicts and to support the construction of military and nuclear weapons, thereby increasing energy consumption.
The theoretical association between economic growth and energy consumption underpins on several hypotheses. These include the growth hypothesis, the conservation hypothesis, the feedback hypothesis, and the neutrality hypothesis. Trade openness also plays a key role, as it affects energy consumption by encouraging the relocation of polluting industries, boosting manufacturing and transportation, and facilitating the import of energy-efficient technologies. Several country-specific and cross-country studies have explored the connection between trade openness and energy consumption, but there is no consensus on the nature of this relationship.
Energy economists have yet to reach a common understanding of the drivers of energy demand. The ambiguity and contradictions related to the drivers of energy demand may be attributed to several factors, including the use of different variables in energy demand functions, the use of proxies for renewable and non-renewable energy demand, and the varying modelling techniques employed to estimate energy demand.
Key Findings show that financial development is a significant driver of energy consumption in India. By encouraging energy-efficient techniques, financial development reduces both renewable and non-renewable energy consumption. Geopolitical uncertainty temporarily reduces non-renewable energy consumption; however, in the long run, positive geopolitical uncertainty shocks escalate renewable energy consumption. This supports two key observations: first, there is short-run complexity and long-run flexibility in the shift from non-renewable to renewable energy consumption. Second, renewable energy can serve as a potential safe haven against non-renewable energy amid rising wars, terrorism, military conflicts, and nuclear-related threats. Additionally, we find that trade openness and per capita GDP are essential drivers of energy demand, influencing both renewable and non-renewable energy consumption in India.
Conclusion
The non-linear ARDL model revealed that financial development is a significant driver of both renewable and non-renewable energy consumption in India. Financial development was found to reduce both types of energy consumption, possibly because the development of India's financial sector has encouraged the adoption of low-energy-consuming or energy-efficient technologies. Additionally, geopolitical uncertainty was shown to reduce non-renewable energy consumption in the short run, while in the long run, increasing geopolitical uncertainties led to higher renewable energy consumption. These findings suggest that renewable energy could serve as a potential safe haven against non-renewable energy amid rising wars, terrorism, military, and nuclear-related threats. Furthermore, we concluded that, for an economy like India, shifting consumer preferences from non-renewable to renewable energy on short notice is complex. However, there is considerable flexibility in the long run to shift energy consumption patterns. We also found that economic growth and trade openness are essential drivers of energy demand.
In light of our findings, it is evident that financial sector development reduces both renewable and non-renewable energy consumption. This finding urges policymakers and the government of India to build a robust financial system that attracts more investments in energy-efficient technologies. Second, our results suggest an association between energy consumption and geopolitical uncertainty. Rising uncertainties increase renewable energy consumption in the long run and have no impact on non-renewable energy consumption, implying its safe-haven status against non-renewable energy. This highlights the importance of considering geopolitical uncertainty in policy formulation. Third, rising per capita GDP increases both renewable and non-renewable energy consumption, with renewable energy consumption being more sensitive to rising incomes. Therefore, the best way to shift from non-renewable to renewable energy consumption is to raise per capita income.
