dp 2012-29

Disaggregate Energy Consumption and Industrial Output in Pakistan: An Empirical Analysis

Ahmer Qasim Qazi, Khalid Ahmed, and Muhammad Mudassar Wuhan University of Technology

Abstract The study concentrates on the relationship between disaggregate energy consumption and industrial output in Pakistan by utilizing the Johansen Method of Cointegration. The results confirm the positive effect of disaggregate energy consumption on industrial output. Furthermore, bidirectional causality is identified in the case of oil consumption, whereas unidirectional causality running from electricity consumption to industrial output is observed. Moreover, unidirectional causality has been noticed from industrial output to coal consumption although there is no causality between gas consumption and industrial output. It is obvious that conservative energy policies could be harmful to the industrial production; therefore, the government has to develop innovative energy policies in order to meet the demand for energy. Additionally, the government has to pay serious attention to alternative energy sources such as solar and wind in order to boost the clean industrial growth.

JEL Q 42; C32 Keywords Disaggregate energy consumption; industrial output; Johansen cointegration test

Correspondence Ahmer Qasim Qazi, School of Economics, Wuhan University of Technology, 430070 Wuhan, P.R. China; e-mail: [email protected]

Author(s) 2012. Licensed under a Creative Commons License - Attribution-NonCommercial 2.0 Germany

Discussion Paper No. 2012-29 | June 25, 2012 | http://www.economics-ejournal.org/economics/discussionpapers/2012-29

www.economics-ejournal.org 1

1 IntroductionThelevelofindustrialoutputisdeterminedbytheavailabilityandefficientutilizationofenergyresources alongwith inputs of labor and capital. The significant role of the energy in theproduction process leads researchers to indentify the relationship between energyconsumptionandeconomicgrowth.

TheindustrialsectorofPakistanisthelargestuserofenergy,consumingabout40%oftheenergyintotal(Pakistanenergyyearbook2009)anditcontributesabout26%totheGDP(CIAWorldFactbook2010).The industrial sector isemployingabout20%of the total labor force(CIAWorld Factbook2010)whichmakes iton thirdplace in absorbing the labor force afteragricultureandservicessector.The industrialsectorhasenormouscapacity tocontribute totheeconomyatahigher leveland toabsorbmore labor force,provided itgets through thesocioeconomicproblems,suchaspoliticalinstabilityandenergyshortages.

Thelargescalemanufacturingannualgrowthratehasbeendroppedfrom18.8%in200405 to 8.2% in200809 (EconomicSurveyofPakistan200910).Analmost similar trendhasbeenseen inmostofthesmallscalemanufacturing industries.Thecorereasonsbehindsuchdeterioratinggrowth inthe industrialsectoraresevereenergyshortages(MinistryofFinanceandEconomicAffairs20102011).Therefore,itisimportanttoconductastudy,particularlyfortherelationshipbetweenindustrialoutputandenergy,sothatreliableimplicationscouldhavebeendrawn inorder to sketch theenergypolicies towards a favorable and clean industrialgrowth.

The following study concentrates on the relationship between industrial output anddisaggregateenergyconsumptioninPakistan.Thestudyisthefirst(tobestofmyknowledge)toanalyzethe linkagebetween industrialgrowthanddisaggregateenergyuse inthecaseofPakistan.Previousstudiesonthistopicweremadeattheaggregateleveloftheeconomy(seeAqeelandButt2001;Zahid2008;JamilandAhmed2010;andShahbazandLean2012).Theuseof aggregate datawould hardly be useful to effectively distinguish between the particularenergy impact on output as well the dependency of different energy resources of theparticularcountry(Ramazanetal.2008andYang2000).

Theremainderof thepaper isorganizedas follows:Section2providesashortreviewofthe literature, Section 3 introduces the methodology and data, Section 4 discusses andanalyzestheresultsandatthelastSection5concludesthestudywithrecommendations.

2 BriefLiteratureReviewThedirectionofrelationshipbetweentheenergyconsumptionandincomehasbeenthetopicofenquiryafterthepioneerworksofKraftandKraft(1978)whoconductedthestudyforthe


USandfoundcausalityfromincometoenergyuse.Sincethen,plentyofresearcheshavebeencarried out by adopting differentmethods and techniques on the topic and obtainedmixresults. The reasons formix results could be found in the differences in the availability ofenergy resources, in infrastructure and in the structure of the economies in the countriesstudied.

YuandChoi(1985)conductedasimilarstudyforSouthKoreaandfoundcausalityrunningfrom income toenergyconsumption, thesameresultasofKraftandKraft (1978).Followingstudieswereconductedfordifferentcountrieswithdifferentmethodologiesandascertainedthecausalityfromincometoenergyuse:ErolandYu(1987)forWestGermany,Abosedra and Baghestani(1989)fortheUS,MasihandMashi(1996)forIndonesia,SoytasandSari(2003)forSouth Korea and Italy, Wolde-Rufael (2005) for five African countries, Narayan and Smyth (2005) for Australia and Lee (2006) for France, Italy and Japan.

At the same time contrast resultswere obtained inwhich causalitywas running fromenergyconsumptionto incomebyYuandChoi(1985)forthePhilippines,ErolandYu(1987)for Japan, Stern (1993) for theUS,Masih andMashi (1996) for India and Indonesia, Stern(2000)fortheUS,SoytasandSari(2003)forTurkey,France,GermanyandJapan,WoldeRufael(2004)forShanghaiandLee(2005)foreighteendevelopingcountries.

However, numerous studies evidenced the bidirectional causality for the energyconsumptionand income,e.g.ErolandYu (1987) for Japanand Italy,HwangandGum (1992)forTaiwan,Masih andMasih (1996) forPakistan,AsafuAdjaye (2000) forThailand and thePhilippines,SoytasandSari(2003)forArgentina,GhaliandElSakka(2004)forCanada,WoldeRufael(2005)forGabonandZambiaandLee(2006)fortheUS.

Therearemanystudieswhichdidnotfindcointegrationbetweenenergyconsumptionandoutput.Thefollowingstudiesobtainednocausalitybetweenthetwovariables:AkarcaandLon(1980),YuandHwang (1984),YuandChoi (1985),ErolandYu (1987) for theUS,MasihandMasih (1996) forMalaysia,Singaporeand thePhilippines,AsafuAdjaye (2000) for Indonesiaand India, Soytas and Sari (2003) fornine countries,Altinay andKaragol (2004) for Turkey,WoldeRufael (2005) for eleven African countries, Lee (2006) for theUK,GermanyandSwedenandSoytasandSari(2006)forChina.

As regards Pakistan, countable empirical researches were conducted at aggregate anddisaggregate level.Butnonehas investigated therelationshipbetween industrialoutputandenergyconsumption.At theaggregate level,AlamandButt (2002)andQaziandRiaz (2008)foundthebidirectionalcausalitybetweentheenergyconsumptionandincome.Unidirectionalcausality running fromenergy consumption togrowthwasevidencedbyKhanandQayyum(2007)inPakistan,atthetimestudieswereconductedforSouthAsianeconomies.

AqeelandButt(2001)conductedastudyatthedisaggregateenergyconsumptionlevelinPakistan to identify the causality between economic growth and disaggregate energyconsumption and found unidirectional causality from electricity to growth and economic


growthtopetroleumconsumption.Furthermore,theydidnotfindanycausalitybetweengasconsumption and economic growth. Zahid (2002) studied the relationship in South Asiancountriesand foundcausality running fromcoalconsumption toeconomicgrowthand fromeconomic growth to electricity consumptionwhich isopposite to the findingsofAqeel andButt(2001)forPakistan.JamilandAhmed(2010)foundthecausalityrunningfromeconomicgrowthtoelectricityconsumptionwhereasbidirectionalcausalitywasobtained inelectricityandeconomicgrowthbytheShahbaz&Lean(2012)withsomespecificationchanges.

3 DataandMethodologyThe annual data has been collected for the period 19722010 from the different reliablesources.Theindustrialoutputisrepresentedbythevalueadded(INTVA)attheconstant2002US$obtainedfromtheWorldBankdataindicators.Theenergyconsumption(EN)isinfluencedbythepricelevel.Thereforethepricevariableisselectedtobeincludedinthemodel.

Sincethedataforenergypricesarenotavailable,weusetheConsumerPriceindex(CPI)torepresent theenergyprices1 and the employment rate (EMP) to representemployed laborforce.AlldataareobtainedfromtheWorldBankdataindicators.Oilintons(OIL),gasinmmcft(GAS), electricity inGwh (ELE) and coal in 000metric tons (COL) are used as disaggregateenergy consumption variables and are collected from the different published economicsurveysofPakistan.Alldataareconvertedintologarithmformsandadjustedbyseason.

ThestudyemploystheJohansenMaximumLikelihoodapproach(Johansen1988;Johansenand Juselius 1990,1992) to establish the statistical relationshipbetween the variables. TheJohansen(ML)procedureallowsustoobtainthemultiplecointegratingrelationships.Besidesidentifyingthelongrunassociationbetweenthevariables,thetestalsoprovidesthelongruncoefficientsofthevariables.ThetestisbasedontheVAR(VectorAutoregressive)approachtocointegration inwhich all variables are considered to be endogenous. The outcome of theJohansencointegrationtestissensitivetotheselectionoftheoptimallagsusedinthemodel,thereforeAkaikeInformationCriterion(AIC)isadoptedinthemodelselection.

Oncethe longrunassociationhasbeenestablishedthroughtheJohansen(ML)approach,it is equally important to measure the shortrun coefficients as well as the direction ofcausality between the variables. This requires the application of Vector Error CorrectionModels(VECMs)whicharealsoknownasrestrictedVARmodels.Sameas intheunrestrictedVAR environment, in VECM all variables in the system are considered to be endogenousvariables,sothenumberofequationsbecomesequaltothenumberofvariables.InourstudyVECMscouldbewrittenasfollows:_________________________1Similar proxy of energy prices is selected in the study of G. Hondroyiannis et al (2002).


(1)

(2)

(3)

(4)

where EN represents the particular disaggregate energy variable under considerationandarethenormallydistributederrorterms.Theterm intheequationsrepresentstheerrorcorrectionand itscoefficientmeasuresmovementawayfromthe longrunequilibrium.Thestatisticallysignificanceof suggeststheexistenceof longrunrelationshipbetweenthevariables.

At last,thedirectionofcausalityhasbeen identifiedofthecointegratingvariablesundertheVECM.TheVECMallowsus toobserve thecausalityby implying the jointsignificanceofthelaggedtermsofeachofthevariablesintheequations.Furthermore,jointshortandlongruncausalityismeasuredbythejointsignificanceofthe andlaggedtermsofeachofthevariables.

4 EmpiricalResultsandDiscussionThe first and foremost thing to do is to determine whether the series of variables arestationaryornot.Theregression issaidtobespuriousormeaningless inthepresenceoftheunitroot intheseries.Thecointegrationtest issubjecttoapplywhenthevariableshavethesameorderof integration. Therefore, the study follows theAugmentedDickey Fuller (ADF)(Dickey and Fuller 1979) and PhilipsPerron (PP) tests (Philips and Perron 1988)in order todeterminethelevelofintegrationbetweenthevariables.Table1showstheresultsofunitroottestsintheseries.Thetestsconfirmthatalltheseriesofvariablesbecomestationaryafterthefirstdifference. Italsoshowsthatallthevariableshavethesameorderof integrationthat isI(1).


Table1:ResultsofUnitRootTests

Variables ADF PP IntegrationOrder Level First

DifferenceLevel First

Difference

LINTV 1.602795 4.616108*** 1.44582 4.61432*** I(1)LEMP 2.778589 6.345296*** 2.79711 6.3982*** I(1)LCPI 2.173726 6.167524*** 2.15874 6.16752*** I(1)LOIL 1.525963 4.058571*** 1.48306 4.20482*** I(1)LGAS 1.529622 3.377733** 1.45144 2.84214** I(1)LELE 0.637163 5.854672*** 0.63716 5.85467*** I(1)LCOL 0.280722 7.082369*** 0.26664 7.01123*** I(1)

Note:AlltheregressionsofunitrootwiththeInterceptterm.***and**denotesignificanceatthelevelof1%and5%,respectively

Thenextstep that followsafterascertaining theorderof integration isanapplicationofJohansen Cointegration test. The study follows two tests statistics developed by Johansen(1988)andJohansenandJuselius(1990).TheonistheTracetestandtheotheristheMaximalEigenvaluetest.Bothtestsareconductedtofindoutthecointegratingvectorsinanequation.TheTracetest isappliedonthenullhypothesisthat isthenumberofcointegratingvectors isless than or equal to r, against the alternative hypothesis that there are more than rcointegrated vectors. Whereas the Maximal Eigenvalue test is conducted under the nullhypothesis of r cointegrating vectors against the alternative hypothesis that there are r+1cointegratingvectors.TheresultobtainedthroughtheJohansenCointegrationtestwouldbedelicate to the selectionof lags in themodel.Thereforeweemploy theAkaike InformationCriterion(AIC)undertheVARenvironmentsystemtoselecttheoptimallaglengthusedinthemodel.TheAICconfirmedtheoptimallaglengththatis2.Table2exhibitstheresultsofTraceStatistics andMaximal Eigenvaluewhich confirm that the variables have a unique longrunassociation.

Once the longrun relationship is found, subsequently we can analyze the result ofestimatedcoefficientsofthe longrun.Table3showsthe longruncoefficientswhichwecaninterpretaselasticitiesbecause theestimatedmodel is in log linear form.The result showsthat thedisaggregateenergyvariablesandemployment levelareallsignificantlyaffected totheindustrialvalueaddedinthelongrun.ThecoefficientsofLOILandLCOLarethesamethatis0.21whichsuggeststhata1%riseintheconsumptionofoilandcoalintheindustrialsectorwould lead to a 0.21% rise in the value added output. The contribution made by the


Table2:JohansenCointegrationTestResults

Hypothesis TraceStatistics MaximumEigenvaluer=0 168.4058*** 57.83301***r=1 110.5728*** 43.72134**r=2 66.85145 24.64831r=3 42.20314 15.52144r=4 26.6817 12.39947r=5 14.28223 9.653723r=6 4.628503 4.628503

***and**denotetherejectionofnullhypothesisatthelevelof1%and5%

Table3:LongrunEstimatedCoefficientsDependentvariable:LINTV

Regressors Coefficients tstatisticLEMP 0.144 2.54**LCPI 0.024 0.861LOIL 0.206 6.47***LGAS 0.572 5.93***LELE 0.052 2.93*LCOL 0.207 2.01*INTERCEPT 11.87 17.1

***,**and*denotesignificanceatthelevelof1%,5%and10%,respectively

consumptionofgas isthehighestamongtheotherenergysources,thecoefficientofLGAS is0.57,whichmeans thata1% rise in thegasconsumptioncausesa0.57% rise in theoutputlevel.Attheend,a1%rise inelectricityconsumption leadsonaveragetoa0.05%rise intheindustrialoutput.Theresultsconfirmthatthereasonforthedeterioratingperformanceofthemanufacturing sector (large and small scale)was the acute shortage of the availability ofenergy(MinistryofFinanceandEconomicAffairs20102011).


Table4:EstimatedShortRunCoefficientsDependentvariable:LINTV

Regressors Coefficient tstatisticLEMP(1) 0.031 0.293LEMP(2) 0.087 0.830LCPI(1) 0.035 1.555LCPI(2) 0.002 0.186LOIL(1) 0.063 2.470**LOIL(2) 0.108 2.245**LGAS(1) 0.204 1.599LGAS(2) 0.019 0.10LELE(1) 0.041 2.475*LELE(2) 0.003 2.100*LCOL(1) 0.15 1.50LCOL(2) 0.16 1.79INTERCEPT 0.071 4.000ECM(1) 0.35 2.959***DiagnosticTestStatistic TestStats PvalueSerialCorrelation 1.440 0.6913Normality 2.952 0.228503Heteroskedasticity 0.761 0.5726ARCHTest 0.0087 0.9247Remsey 0.0002 0.9821Rsquared 0.5638


Table 4 exhibits the shortrun results based on theVECM. The results suggest that theelectricityconsumptionandtheusageofoilproductssignificantlyaffectheindustrialoutputintheshortrunaswell.Firstly,therehasbeenadecreaseintheoilconsumptionintheindustrial


sector(MinistryofPetroleumandNaturalResources,2009)becauseofhighoilpricesandtheavailabilityofgasasacheapalternativeenergysource,butinourresultsstilltheoilproductscouldsignificantlyinfluencethelevelofindustrialoutput.Secondly,30.2%electricityhasbeenconsumed by the industrial sector (Pakistan Energy Yearbook, 2009) which is a sufficientindicatortoconfirmourresultthattheelectricityconsumptionhasshortrunsignificanteffectonthe industrialoutput.Thestatisticallysignificancewiththenegativesignofthecoefficientof the error correction term indicates the longrun relationship between the variables.Furthermore,thecoefficientofecm(1) is 0.35whichshowsthatwhenthe industrialoutputwouldbeinandisequilibrium,itgetsadjustedby35%inthefirstyear.Itcanbeconcludedthattheprocessofadjustmenttotheequilibriumissignificantlyquickenoughtorespondanyshocktotheindustrialvalueaddedequation.

ThediagnostictestsarealsoconductedforthemodelwhichispresentedatthebottomofTable5. The results show thatwe cant reject the null hypothesis of not serially correlatedvariables. Residuals are normally distributed, residuals are homoscedastic, there is no archeffect and themodel iswell specified. TheRsquared testis reasonablehigh to confirm thegoodness of fit of themodel. At last, to check the stability of themodel,we employ thecumulativesumoftheresidualandthecumulativesumofsquareoftheresidualmethods.TheresultsarepresentedinFigures1and2.Theyconfirmthestabilityofthecoefficientssincetheplottedresidualsarewithinthecriticalboundsatthe5%levelofsignificance.

Figure 1.Cumulative sum of recursive residual Figure 2.Cumulative sum of Square recursive residual

-15

-10

-5

0

5

10

15

92 94 96 98 00 02 04 06 08 10

CUSUM 5% Significance

-0.4

0.0

0.4

0.8

1.2

1.6

92 94 96 98 00 02 04 06 08 10

CUSUM of Squares 5% Significance


Table5:ShortRunCausalityTestResultsBasedonVECMVariableFstats tstat

INTV LEMP CPI OIL GAS ELE COL EN ECTINTV 0.3640 1.336 4.098** 1.313 4.126*

1.630

4.285** 2.953***

LEMP

0.302

2.557

0.313

0.181

0.162 2.004

0.732

0.060

CPI 0.339

0.064

4.789**

0.039

0.958

1.554

0.793

2.782**

OIL 2.640*

0.624

0.153

0.323

GAS 0.677

2.259

2.836*

1.609

ELE 0.735

0.578

0.136

0.591

COL 4.547**

1.195

1.199

3.288**

***,**and*denotesignificanceatthelevelof1%,5%and10%,respectively.ECTrepresentstheErrorCorrectionTerm

Theanalystand,more importantly, thepolicymakersare concernedabout thedirectionofcausalitypresentedbetweenthevariables.Inthisregard,Table5exhibitstheresultsofshortruncausalitytestbasedontheVECM.TheresultsareobtainedthroughtheWaldtestofjointsignificance of the variables. The Fstatistics show the presence of bidirectional causalitybetweenoilconsumptionandindustrialoutput,whereasunidirectionalcausalityrunningfromelectricity consumption to industrial output is obtained. The joint significance test is alsoappliedbycombiningalldisaggregateenergysourcesandconfirmstheunidirectionalcausalityfrom energy usage to output growth. The results also identify the oneway causality fromoutputtocoalconsumption.ThisresultconcernsthecementandBrickKilnsindustriesbecausetheir combined coal consumption is about 80% of the total coal usage (Pakistan EnergyYearbook,2009).ThereisnosurprisetoidentifythecausalityfromoilconsumptiontoCPI;therisingoilimportbillwouldsignificantlycontributetothedomesticinflation.


Table6:JointShortRunandLongRunResults(Fstat)Variable

INTV&ECTt1

LEMP&ECTt1

CPI&ECTt1

OIL&ECTt1

GAS&ECTt1

ELE&ECTt1

COL&ECTt1

EN&ECTt1

INTV 3.143**

3.027*

3.546**

3.103**

3.956**

4.013**

2.302*

LEMP

0.207

2.275

0.255

0.155

0.110

1.501

0.744

CPI 3.538**

2.606*

3.236**

3.562**

2.760*

4.480**

2.467**

OIL 1.780

0.458

0.104

GAS 1.014

2.318

2.451

ELE 0.660

0.506

0.149

COL 5.248***

2.391

1.882


Table6showsthejointshortandlongruncausalityresults.Itisobservedthatinindustrialoutput equation; disaggregate energy variables, employment and CPI are all statisticallysignificant combined with the error correction term. It is interesting to note that alldisaggregateenergy consumption significantly causes the inflationofa country in the shortand long run.Furthermore, industrialoutputandemploymentplayalsoa significant role tocause theCPI. Theunidirectional causality is identified fromoutput to coal consumption incombinedshortandlongruncausality.

5 Conclusion

The energy shortage is one of themain reasons of the downturn of the industrial sector,particularly in the largescalemanufacturing.Asa result,plentyof smallscale industriesareshutdownandmanyof largescale industriesaremovingoutofPakistan. In thisregard,thecurrentstudyisabouttherelationshipbetweenthedisaggregateenergyconsumptionandtheindustrialoutput.Thetimeseriesanalysisisconductedfromtheperiod19722010.


We have employed the Johansen cointegration test in order to realize the longrunrelationshipbetweenthevariables.Thelongrunestimatedcoefficientsofdisaggregateenergyconsumptionaresignificantandpositivelyaffectedtotheindustrialoutput.Ontheonehand,VECM is employed to obtain the shortrun coefficients in which the oil and electricityconsumptionarefoundtobestatisticallysignificant.Ontheonehand,thedisequilibriumgetsadjustedby35%fromlastyeartocurrentyear.

Theshortrunbidirectionalcausalityhasbeenseenbetweentheoutputandoil,whereasunidirectionalcausalityhasbeen identifiedwhich is running fromelectricityconsumption toindustrial output. This suggests that it would be harmful for the industrial growth if weobtainedtheenergyconservativepoliciesorwereunabletofulfilltherequireddemandoftheindustrialsector.Theseresultsalsomakearequesttopolicymakerstothinkabouttheuseofalternativeenergysources,suchassolarandwindetc.inordertorespondtotherisingenergydemandoftheindustrialsector.

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