For this week's /r/economics Article of the Week we look at the relationship between income and energy use. The article is The Demand for Energy-Using Assets among the World's Rising Middle Classes by Paul J. Gertler, Orie Shelef, Catherine D. Wolfram and Alan Fuchs which was published in the American Economic Review. UNGATED VERSION HERE.

The summary this week is by me /u/ponderay

Recent growth in energy demand has been mostly driven by increases in energy use in the developing world. As the developing world is expected to continue growing it is important to understand the factors that drive energy demand in nations like China and India. Understanding energy consumption in these growing countries is vital to models forecasting the future path of greenhouse gas emissions and thus the likely costs of global warming.

This paper attempts to explain the s-curve relationship between income and energy use we see in the data on aggregate electricity demand in developing countries. The authors hypothesize that this non-linear relation is due to the presence of borrowing constraints in developing countries. If households have access to reasonably priced credit they can buy electricity intensive appliances,like refrigerators and air conditioners, right away when there is an increase in income. This would lead to a smooth increase in energy use as more and more households decided to buy energy intensive appliances But if there are borrowing constraints households must instead wait until they have enough savings to make the entire purchase. In this case we would see very little growth in energy use as income increases until a certain value where households would finally be able to purchase appliances. At this point electricity use would grow rapidly before eventually flattening out.

The authors write down a formal model of this process which generates three important predictions. First we have the s-curve relation between appliance owner ship rates(and thus energy use) and income. The percent of the population who owns appliances should grow slowly at first then as income increases it should grow rapidly and eventually growth will slow down again. The second prediction is that all else equal, borrowing constraints imply that households who receive income latter will be more likely to buy appliances latter. That is if we imagine two households who both earn the same amount of income in a given two year period. The household that earns the majority of their money in year two are more likely to buy a refrigerator then the other household that earns the majority of their money in year one. Lastly, due to technical reason, the effect of moving income to a latter period should increase purchases even more as income increases. These predictions provide the authors a way to tell if borrowing constraints are important or not. If borrowing was easy households would react to their total income over a time period and the timing wouldn't matter.

To test this theory empirically the authors turn towards a famous cash transfer program to poor rural populations in Mexico called Oportunidades. The program gave cash transfers to family conditional on participating in a health education program. In addition cash payments were given for each child in school. Most importantly for this paper the participants were divided in to two groups randomly. One group would be enrolled in the program immediately while the other had to wait a year. This is important as it gives the researchers randomized variation in the timing of income, which means the author can treat the program as a randomized trail meaning that any results are likely free from statistical bias and can be taken as causal.

The data from the program confirms the theory. A s-curve can be seen in the data collected for the program. Furthermore the data is consistent with the predictions of how agents would act in the presence of borrowing constraints. Households who enter the program latter are much more likely to purchase refrigerators. In fact, households in the second period behave like households in the first period with an additional 6,000 dollars in income.

What are the implications of this? First these results highlight the importance of borrowing constraints in shaping behavior and well being in developing countries. By make large purchases more difficult, borrowing constraints keep households from the health benefits of refrigeration and air conditioning. Secondly these results have implication for models forecasting future emissions. Because many of these models assume a linear relation between energy and electricity consumption, this paper implies that those models are understating future increases in emissions from income gains in China and India.