Welcome to the second session of MEDEAS’economy module topic. Today, we will learn how the
MEDEAS’ economy module works. After having set our theoretical framework
in the previous session, we need to translate it into the model’s structure. So, we have
built an economic module, which allows us to represent the final energy demand as accurately
as possible. So, in this session, the general framework will be described, and the structure
and module and some examples will be shown. But first, just a quick reminder on the role
played by the economy module in MEDEAS. Basically, the economy module triggers energy demand,
which makes the energy module extract primary energy sources from the environment and transform
them into the final energy that is being demanded by final users within the economic system.
As can be seen in this overview chart, the economic activity is, either directly or through
the energy module, what brings about energy and material carriers, as well as pollution
impacts. However, because the economy cannot trespass biophysical boundaries, the relationship
between energy and economy is two-way. Therefore, it is important to set a realistic
energy-economy nexus. This link has been traditionally pictured as a linear one-way relationship.
Regardless of the causality direction here, what the data are telling us is that it takes
energy to produce economic output. So, we can all agree on this direct relationship.
However, what is often missing in models is a feedback so that, if the energy inflows
to the economy are lower than required to meet a certain growth rate, then the result
will be a gdp slowdown. As we have a stock of non-renewable energy sources and renewable
energy source potentials, which will be explained in the next module, and the energy flows to
the economy depend on them, as well as infrastructures and their productive capacity, the economy
must dynamically adapt to the net energy availability in every simulation period and, therefore,
to biophysical boundaries. Therefore, it is important to set a realistic
energy-economy nexus. This link has been traditionally pictured as a linear one-way relationship.
Regardless of the causality direction here, what the data are telling us is that it takes
energy to produce economic output. So, we can all agree on this direct relationship.
However, what is often missing in models is a feedback so that, if the energy inflows
to the economy are lower than required to meet a certain growth rate, then the result
will be a gdp slowdown. As we have a stock of non-renewable energy sources and renewable
energy source potentials, which will be explained in the next module, and the energy flows to
the economy depend on them, as well as infrastructures and their productive capacity, the economy
must dynamically adapt to the net energy availability in every simulation period and, therefore,
to biophysical boundaries. With a more in-depth insight, the economy
module works according to this overview. First of all, gdppc and population scenarios lead
to an exogenous demand shock, giving our sectorial demand function the expected labour compensation
and profits for the current period. This function estimates the final demand of products and
services made by 5 institutional sectors from 35 different industries. Then, we calculate
the production required to satisfy this sectorial final demand through an input output analysis
of both direct and indirect effects. After that, by using energy coefficients, which
are the energy intensities, energy demand by the 35 sectors and 5 final energy sources
are obtained. In parallel, the energy module estimates the final energy supply according
to its structure, which has been described in the previous module. If the final energy
available by any source is lower than the final energy demand, then a scarcity coefficient
is calculated and not all the production firstly estimated can actually be produced to satisfy
demand. This begins a backwards analysis, whereby we obtain the feasible production
and demand, which at the world level is equal to gdp. So, energy demand would be a function
of energy intensities, the economic structure being represented by leontief matrix and final
economic demand; which, in turn, as mentioned before, is a function of income and its sectorial
features. The 5 institutional sectors that demand goods
and services from the 35 economy branches are households, non-profit organisations serving
households –which have been integrated in just one institutional sector- corporations
making gross fixed capital formation, or most commonly known as investment; governments
and the residual changes in inventories. Because MEDEAS-world takes the global economy as one
country with no external sector, exports are not included. Nevertheless, rest of the world
is one more institutional sector in MEDEAS-europe and MEDEAS-country, which enables including
exports. Although panel data regressions were run to
estimate final demand functions for each institutional sector, except government expenditure and
changes in inventories, which remain a constant proportion of the final demand, coefficients
are open for the user to be re-estimated. The standard structure of final demand relies
basically on the expected and the previous year’s income. Hence, final demand is path
dependant and expectations-sensitive. Furthermore, the input-output analysis is
a methodological framework whose main advantage is that it allows both direct and indirect
production carriers of the final demand to be estimated. Let me illustrate this with
a quick and simple example. Imagine an economy with 3 sectors: agriculture and raw materials,
industry and services. Whenever a household (or a corporation, or the government) demands
services from the service sector, it’s not only this sector which produces a monetary
output. They will need products manufactured from
the industry sector and they, in turn, will require raw materials to produce them. As
a consequence, if services are demanded, it will also make the other sectors produce output.
Input-output analysis is also very suitable for hybrid economy-environment assessments.
Fortunately, input-output databases have been improving quite quick lately, so we can use
the final energy required by each sector to produce one unit of output, namely the energy
intensity of 5 final energy sources. Thanks to the hybrid input-output analysis, we will
be able to calculate direct and indirect energy carriers of the final demand, broken down
by final energy sources. After a few transformations needed to operate
the input-output analysis, we can track down which sectors are more energy intensive, and
the ones that rely the most on dirty, non-renewable energy sources. Let’s have a look, for example,
at the energy sensitivity of the world economy for the last year available in our database.
Basically, it measures the final energy carriers in ej triggered by an additional million $ of
economic output. For many people, the reliance of sector 1 (agriculture, forestry and fishing)
on liquids is striking. We can also see the high dependence of mining sectors and refineries
on gases, liquids and solids, mainly natural gas, oil and coal. On the other hand, we can
see how other sectors, such as education, health, or other community services, are less
energy-sensitive. This kind of information is very useful for
policy-makers, but also for the modeller to make decisions in MEDEAS. The demand for non-renewable
energies can be lower in scenarios where the energy intensity drops sharply, an energy
mix shift is operated and or a deep economic structure change also occurs. For the sake
of simplicity, in this course, we will keep economic structure static, but industrial
policy favouring less energy-intensive sectors to the detriment of the more energy-intensive
ones is an important policy for energy transition. Now, we are prepared to have a look at some
model examples, which can illustrate how the energy-economy feedback works. For this purpose,
we have run the model with and without the feedback. Let’s take a particular sector,
say sector 15 of transport equipment. Here we can see the final demand of this sector’s
products or services if we disregard energy availability.
As a result, according to the economic structure, this sector needs to produce a certain amount
of output, which in turn encompasses this demand of final energy sources. We can see
the electricity demand share rising as electrification goes ahead in the model. If no feedback is
considered, production is satisfied and the economy-wide gdp can keep on growing.
But if we include the energy-economy feedback, the model will tell us a different story.
Now, if energy inflows to the economy are lower than required to grow at the exogenous
rate that we have used, it will just grow at the feasible growth rate given the net
available energy supply for every period. Let’s take the same sector of inland transport.
We see that the supply of liquids doesn’t systematically match demand for this scenario.
As a consequence, the energy actually consumed is lower than expected and, therefore, output
is reduced from its expected trend. As a result, gdp suffers a slowdown in the
next period and the following years. Meanwhile, in the energy module, different scenarios
of energy transition are being unfolded, technology is evolving, energy efficiency is improving
at different rates and energy return on investment is being pushed in different directions according
to the type of energy transition chosen. We will go into this in greater depth in the
next module. Finally, we are able to summarize the main
conclusions of this topic as follows: The economic system is a subsystem embedded
in a larger system, the biosphere, and therefore, sustainability should be analysed as a “scale
issue” (the size of the economic system within the biosphere).
MEDEAS’ economy module is a simulation, demand-led and sectorial disaggregated model.
The energy-economy feedback plays a key role to understand the limits and challenges which
energy scarcity poses to economic growth. Economic demand is the main driver of MEDEAS,
because it activates every other module through final energy demand, direct or indirectly.
This has been the final of the MEDEAS economy module topic. Now, you can go deeper on MEDEAS
model and learn how the energy demanded by the economy is generated in the energy module,
which will be explained in topic 3.