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569 586

**The demand for energy in Greek manufacturing
**

Dimitris K. ChristopoulosU

Department of Economics and Regional De¨ elopment, Panteion Uni¨ ersity, Syngrou A¨ e. 136, 17671 Athens, Greece

Abstract This paper considers an econometric approach to measuring substitutability of three types of energy, i.e. crude oil, electricity and diesel with capital and labour in the manufacturing sector of Greek industry during the period 1970 1990. A general dynamic framework is developed under the assumption that the structure of the production process is weakly separable in capital, labour and energy aggregates. The translog total cost function is used to represent the production technology. The main advantages of the proposed dynamic structure are that it is both disaggregated in energy components and consistent with the neo-classical theory of production. 2000 Elsevier Science B.V. All rights reserved.

JEL classifications: C51; D24; Q41 Keywords: Energy; Separability; Dynamic structure

1. Introduction Greek industry has undergone considerable restructuring during the last two decades, bringing great changes in the inputs used, especially of energy. On the one hand, the cost share of capital dropped in every two-digit industry under consideration ŽPalaskas et al., 1999.. On the other hand, the problem of labour scarcity that emerged in the late 1960s and early 1970s Žsee Lianos, 1975. has been

U

Fax: q30-1-9229-315. E-mail address: Christod@panteion.gr ŽD.K. Christopoulos..

0140-9883r99r$ - see front matter 2000 Elsevier Science B.V. All rights reserved. PII: S 0 1 4 0 - 9 8 8 3 Ž 9 9 . 0 0 0 4 1 - 9

570

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

eliminated Žsee Christopoulos, 1995.. The rate of unemployment in 1972 was 1.8% and the emigration rate was still quite high. At the same time, energy emerged as an important input in the production process of Greek manufacturing. The share of the three main sources of energy, crude oil, diesel and electricity, increased significantly during the last two decades, as a percentage of the total cost in the sector ŽPalaskas et al., 1999.. Given these changes in the Greek industrial sector in recent years a number of authors ŽSamouilidis and Mitropoulos, 1982; Vlachou and Samoulidis, 1986; Donatos and Mergos, 1989; Kintis and Panas, 1989; Caloghirou et al., 1997; Palaskas et al., 1999. have focused attention on the degree of substitution among energy sources and primary inputs of production Žcapital and labour.. The question of the degree of energy substitutability is of great importance in predicting economic disruptions arising from energy shortages and it has important implications for public policy. For example, higher energy prices induce cost-minimising firms to substitute toward capital and labour, and higher electricity prices induce firms to substitute towards some combination of capital, labour and alternative energy types. This will have important industrial effects and it will affect capital utilisation, employment, etc. In addition, energy substitutability can assist in addressing important issues, including the feasibility of various energy demand profiles, the evaluation of alternative environmental policies, and the impact of carbon or energy-use taxes. All previous empirical studies of energy substitution in Greek manufacturing suggest that energy and labour, and energy and capital are substitutes, with the exception of Kintis and Panas Ž1989. who found that energy and capital are complements. However, these studies have some shortcomings. All approaches are static and hold only in equilibrium. More specifically, none of the previous studies takes into account the static misspecification errors that arise when an instantaneous adjustment process is not appropriate. The static versions of the models neglect the dynamics of adjustment, which results in inadequate knowledge of the adjustment path and the long-run structure. Knowledge of the adjustment process is important in addressing policy issues arising from alternative tax structures or exogenous energy price shocks. Therefore, under the static specification the estimators will not provide reliable computed elasticity for policy design and policy making. Thus, by assuming a static production model the applied researcher may be led to misguided conclusions. Given the drawbacks of the static models in terms of estimation, hypothesis testing and analysis, a different approach is adopted here. Following Fuss Ž1977. and Pindyck Ž1979. we assume that the structure of production is weakly separable in capital, labour and energy aggregates. With this restriction it is possible to estimate a production structure with producers choosing cost-minimising factor inputs in two stages. First, an energy sub-model is derived from the separability restrictions, and is estimated optimising the mix of crude oil, diesel and electricity and generating an aggregate energy price index. Second, the model optimising the cost of aggregate inputs and explaining the demand for those inputs is estimated.

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

571

To incorporate dynamic adjustments, a general dynamic demand framework is constructed using the translog cost-function. Thus, a dynamic structure of the demand for energy in Greek manufacturing is obtained, which is both disaggregated in energy components, consistent with the neo-classical theory of production, and flexible enough to accommodate a rich pattern of dynamic behaviour. The paper is organised as follows. In Section 2 the theoretical model is presented. The dynamic formulation of the adopted model is contained and analysed in Section 3. In Section 4 the statistical estimation is presented and the empirical results are analysed. Also, in Section 4 we examine whether or not the estimated relationships are structural or spurious. Section 5 concludes the paper.

2. The theoretical model The specification of the model starts with the assumption that the technology applied in the production process can be described by a twice differentiable production function which relates the flow of output to various inputs of production. In algebraic terms it can be expressed as Y s F Ž X j ,T . j s 1,2,3, . . . . . . Ž1.

where Y is the output, X j is the u dimensional vector of inputs j, j s 1,2, . . . n: NÄ 1, . . . ,u4 and T is an index of technological progress. It is assumed in Eq. Ž1. that F Ž X j ,T . is finite for every X and T and continuous for all non-negative Y and X. It is also assumed that monotonicity is valid for F Ž X j ,T . and that the production function is strictly convex, see for example, Diewert Ž1971. and Hall Ž1973.. Next it is assumed that the production function Ž1. is weakly separable with respect to partition Ä N1 , . . . . . . Ns 4 . This means that the marginal rate of substitution ŽMRS. between any two inputs i and j from any subset Ns s Ä 1, . . . . . . m4 is independent of the quantities of inputs outside Ns , see Berndt and Christensen Ž1973a.. In other words,

Xk

ž/

fj

fi

s0 f

for all i , j g Ns and k f Ns .

Ž2.

is the first derivative of F Ž X j ,T .. Xj The assumption of weak separability Ž2. with respect to partition Ä N1 , . . . . . . Ns 4 ensures that the aggregates exist and permits us to write the production function Ž1. in the following form: Y s F Ä X 1 Ž X i . , X 2 Ž X j . , . . . . . . X s Ž X s .4 i s 1, . . . . . . r , S s 1, . . . . . . m. j s 1, . . . . . . l, Ž3.

where f i s

where X 1 Ž X i ., X 2 Ž X j ., . . . . . . X s Ž X s . are aggregated functions with elements labelled by indices i, j and S and X 1, X 2 , X s are aggregate inputs.

572

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

Furthermore, we assume that aggregated functions in Ž3. are homothetic in their components. This assumption provides a necessary and sufficient condition for an underlying two stage optimisation procedure Žsee Denny and Fuss, 1977.: optimise the mix of components within each aggregate and then optimise the level of each aggregate. The existence of homothetic aggregation functions does not imply that the overall production process is homothetic ŽApostolakis, 1988.. Given the production function Ž1. and the associated assumptions, the cost function can be derived. According to duality principles, Samuelson Ž1947., Uzawa Ž1964. and Shephard Ž1970., there is a cost function equivalent to the production function that can represent the technology of production and vice versa. To start with, it is assumed that the cost function that corresponds to the production function can be written as C Ž Pj ,Y ,T . s min P ) X s TC Ž4.

where C stands for total cost, Pj is the vector of input prices, and TC is the total cost. The cost function Ž2. is considered, similarly to Ž1., to be twice differentiable in Pj and T, finite for every Pj , Y G 0 and T, continuous in Y and Pj , linear homogeneous in Pj and Y G 0, non-decreasing in Y and Pj, and concave in Pj . Also the dual cost function Ž4. will be weakly separable if the aggregation in production function Ž1. exists and the aggregate functions in Ž3. are homothetic in their components Žsee Berndt and Christensen, 1973b.. Finally it is assumed that the specifiable factors of production are capital ŽK., labour ŽL., electricity ŽEL., diesel ŽD. and crude oil ŽM.. So the cost function Ž4. can be written as follows: C s g w PE Ž PM , PEL , PD . , PK , PL , Y , T x Ž5.

where PK is the price of capital, PL is the price of labour, PM is the price of crude oil, PEL is the price of electricity, PD is the price of diesel and PE is an aggregate price index of energy, i.e. a function that aggregates the energy prices of three components types. As assumed previously, this aggregator function is homothetic in the mix of energy types.1 Eq. Ž5. can be estimated in two stages: First a sub energy homothetic model with constant returns to scale will be considered to construct an instrumental variable for the price of energy. Second an aggregate non-homothetic cost function associated with Hicks non-neutral technological progress. So, the firms first minimise the energy cost and then the total cost of production. Under the hypothesis of minimisation of total cost ŽTC. the cost function Ž5. may take various forms. The translog form is one, it can be expressed as ŽChristensen et al., 1973.

1 Analogous aggregate functions can be formulated for the other aggregate inputs: capital and labour. However, the lack of disaggregated data for capital and labour for Greek manufacturing make this procedure inapplicable.

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

573

2

lnTC s a o q

Ý ai ln Pi q 1 Ý Ý yi j ln Pi ln Pj q aY lnY q 1 aY Y ŽlnY . 2 2

i

2

i

j

q aT T q 1 aT T Ž T . q 2

Ý

i

Y i lnY

ln Pi q

Ý

i

T i ln Pi T

q

TY

lnYT

Ž6.

where i, j s K,L,E. Under conditions of perfect competition the logarithmic differentiation of Eq. Ž6. with respect to input prices PK , PL , PE yields expressions for the demanded quantity of the corresponding inputs in terms of cost shares ŽShephard’s Lemma., i.e. MiTC s lnTCr ln Pi s Ž Pi X i . rTC s a i q

Ý yi j ln Pj q

j

iY

lnY q

T iT

Ž7.

where X i is the quantity demanded of the production input i and Mi is the cost share of the input i demanded. For the cost function Ž6. to satisfy the adding-up criterion Ý MiTC s 1, i s K,L,E and the properties of the neo-classical production theory, the following linear restrictions must be satisfied,

i

Ý ai s 1,

i

yi j s y ji ,

Ý yi j s Ý

i i

iY

s

Ý

i

Ti

s

i

s0

Ž8.

for i, j s K,L,E. The restrictions Ž8. are necessary and sufficient conditions ensuring TC is linearly homogeneous in input prices. However, the price of energy Ž PE . is considered also to be an aggregate function 2 wsee function Ž5.x. This aggregate function can be represented by a homothetic translog cost function with constant returns to scale ln PE s a o q

Ý

i

i ln Pi

q

1 2

Ý Ý yi j ln Pi ln Pj

i j

Ž9.

**The following energy cost share equations are implied by Shephard’s Lemma: MiE s
**

i

q

Ý yi j ln Pj

j

Ž 10 .

where i, j s EL,D,M. Again the adding-up criterion and the properties of neo-classical production theory require the parameter restrictions

PE it is not a consistent aggregate price index if it is a simple weighted average of the Pi , i s EL,D,M unless the energy components are perfectly substitutable or complements in the production process Žsee Berndt and Christensen, 1974..

2

574

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

Ý

i

i

s 1,

yi j s y ji ,

Ý yi j s 0

i

Ž 11.

to be satisfied by the aggregate function. Let us now review the steps involved in estimating the proposed model: first the sub-energy model Ž10. is estimated subject to the constraints Ž11.. The estimated parameters in Ž10. are substituted into Ž9. to obtain an aggregate price index for energy. Next the factor share Eq. Ž7. is estimated subject to the restrictions Ž8. using the estimated energy price index as an instrumental variable. 3. Modelling the dynamic structure of production using the translog cost function The factor demand system Ž7. derived from the translog total cost function Ž6. is static and holds only in equilibrium. This happens because the existence of convex adjustment costs and the imperfections involved in obtaining information imply that there is some delay in adjusting instantaneously actual capital, labour and energy to their desired level following exogenous price and demand shifts. Analytically, the cost share Eq. Ž7. describes long-run structure. According to Anderson and Blundell Ž1982. changes in the share in total cost MiTC of input i are responses to anticipated and unanticipated changes in capital, energy and labour prices in an attempt to maintain a long-run relationship of the form Ž6. in the sense that, should capital, energy and labour prices stabilise to some constant value over time, then so would the expected share of capital, energy and labour in total cost Ž MiTC .. Furthermore, in the short-run there is uncertainty about the future course of capital, energy and labour prices and output. Therefore, following an exogenous shock the firms do not adjust instantaneously the three inputs, capital, energy and labour to the desired level ŽNissim, 1984.. Thus, ignoring the dynamic element would lead to inadequate knowledge of the adjustment process and of the long-run structure. To model the dynamic form of total cost share Eq. Ž7. 3 the transformation proposed by Wickens and Breusch Ž1988. and Kesavan et al. Ž1993. is used. This transformation identifies the long-run structure together with the short-run dynamics in demand for capital, labour and energy which it merges the long-run steady-state theory with short-run time series properties of data and produces elasticities that are robust for policy implication. In addition one more general dynamic framework is obtained which achieves the desirable aspects of flexibility, simplicity and identification of long-run parameters which can be considered as long side alternative transformations Žsee Anderson and Blundell, 1982; Nissim, 1984; Banerjee et al., 1990.. A way to incorporate the dynamic structure of production in the total cost share Eq. Ž7. is to write the system in the following form:

3 The short-run total cost function remains unspecified in our model because the total cost share Eq. Ž6. contains all the information necessary to derive estimates for the long-run demand for energy and input energy and non energy substitution.

**D.K. Christopoulos r Energy Economics 22 (2000) 569 586
**

L L

i k Mi ,tyk q a i q

575

L

L

i j ln Pj,tyk q

MiTC s

Ý

i ,ks1

Ý

j,ks0

Ý

j,ks0

i j lnYtyk q

Ý

j,ks0

T i Ttyk

Ž 12 . where in our application only the lag structure, k s 1 will be used. The equations in the system Ž12. can be transformed by subtracting

L

Ý

ks1

k

Mt

**from both sides of Ž12. ŽWickens and Breusch, 1988; Kesavan et al., 1993.. By algebrical manipulation we obtain
**

L L

ik TC q ai q k Mi

MiTC s

Ý

i ,ks1

Ý

j

i j ln Pj q

iY lnY q

T iT y

Ý

j,ks1

ij

k ln Pj

y

iY

k

lnY y

iT

kT

Ž 13.

where refers to annual differences and i s K,L,E. In a similar way we transform the share Eq. Ž10. derived from the aggregator energy function, obtaining

L L

i ,K K

MiE s

Ý

i ,ks1

MiE q

i

q

Ý

j

i j ln Pj

y

Ý

j,ks1

ij

K ln Pj

Ž 14 .

i s EL,D,M.

4. Statistical estimation 4.1. The estimation of the sub-energy model Empirical implementation requires that the energy share Eq. Ž14. should be statistically specified. Consequently, an error term is added to each equation because of lags of cost in response to the changes in exogenous variables. Since the shares of the three energy inputs ŽEL,D,M. always sum to unity Žadding-up criterion Ý MiE s 1, i s EL,D,M. the sum of the disturbances across the three share energy equations is zero at each observation. This implies a singular disturbance covariance matrix. Therefore, in order to avoid singularity, one share equation must be dropped Žthe equation of crude oil is deleted.. Following Anderson and Blundell Ž1982. for the invariance of results due to arbitrary deletion of one equation the restriction that the adjustment coefficients must be equal across equations together with the one for long-run symmetry is considered for the general dynamic form Ž14.. Non-linear iterative Zellner estimation Žsee Zellner, 1962, 1963. is used to estimate the parameters of the dynamic model Ž14.. This procedure, which is equivalent to maximum likelihood estimation ŽKmenta and Gilbert, 1968., assures

i

576

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

**Table 1 Tests of dynamic structure for the energy-sub model
**

2

Number of restrtion 4 5

2 0.95

2 0.90

2 0.75

Partial adjustment Static

13.890 12.428

9.488 11.070

7.779 9.236

5.385 6.625

that the estimates will be invariant to which the equation is deleted only under the acceptance of null hypothesis of error correlations across equations Žsee Berndt and Savin, 1975; Christopoulos, 1995.. For the reasons presented above, the IZEF method is adopted for estimating the two dynamic equations in Ž14., using annual data from the Greek manufacturing sector for the period 1970 1990.4 Also, its partial adjustment and the static specifications of the general dynamic form Ž14. are estimated and compared against the general specification Ž14..5 Starting with the statistical comparison between the general dynamic, the partial adjustment and the static specification of the dynamic share energy system Ž14., the likelihood ratio test of its dynamic structure is computed. The results are presented in Table 1. The 2 results in the second column of Table 1 reveal that the general dynamic specification of the model Ž14. is superior to its corresponding partial adjustment. Also, the general dynamic specification nests that of static at the 5% level of significance. Therefore, the dynamic specification is adopted to estimate and analyse the own and cross price elasticities of demand for energy components. Parameter estimates for this model are presented in Table 2. Next the own and cross price elasticities are estimated to measure the price responsiveness. It can be shown, that for the translog energy cost function Ž9. under the dynamic specification of share Eq. Ž14., these estimates can be calculated as follow: Ei i s

ii

ˆ MiE

ij

ˆ q MiE y 1

i s EL,D,M Ž 15 .

Ei j s

ˆ MiE

ˆ q M jE

i , j s EL,D,M

where i / j

For the nature and the structure of the variables see Appendix A. The partial adjustment specification results from the imposition of the restrictions i j s 0 on the parameters of the dynamic specification. The restrictions required to obtain the static model are the partial adjustment restriction with the addition of i K s 1.

5 4

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

577

Table 2 Parameter estimates of translog-energy sub model for Greek manufacturing with homogeneity and symmetry imposed in the long-run: 1970 1990 a Equation I Želectricity . Parameters YEL YEL EL YEL D

EL

Equation II Ždiesel. Coefficients 0.669U Ž0.031. 0.232U Ž0.057. 0.0205UUU Ž0.0104. 0.807U Ž0.186. y0.029 Ž0.130. 0.164 Ž0.149. 0.404 0.103 19 10.042 13.348 Parameters YD YDD YDEL

D

Coefficients 0.038U Ž0.004. y0.0126 Ž0.0110. 0.0205U Ž0.0104. 0.807U Ž0.186. y0.004 Ž0.018. 0.008 Ž0.016. 0.565 0.002 19 1.151 1.947

EL EL

DD

EL D

DEL

R2 SSR OBS QŽ5. QŽ10.

R2 SSR OBS QŽ5. QŽ10.

a The numbers in parentheses are the standard errors. U ,UUU Indicate statistical significance at 1% and 10%, respectively. Q denotes the Box Pierce Q statistic for serial correlation in the residuals. The figures in parentheses are the degrees of freedom for 2 statistics. The 5% critical values are 11.070 and 18.307, respectively, for 5 and 10 d.f.s.

The estimates of own Ž Eii . and cross price Ž Ei j . elasticities 6 evaluated at the mean values in the period 1970 1990 are presented in Table 3. It can be seen from Table 3 that all long-run own price elasticites are negative except for crude oil. However, the only result that appears to be statistically different from zero is that for diesel. For this energy component the estimated

Table 3 Estimates of own and cross long-run price elasticities a Electricity ŽEL. Electricity ŽEL. Diesel ŽD. Crude oil ŽM. y0.02 Ž0.10. 0.08U Ž0.02. y0.05 Ž0.11. Diesel ŽD. 1.12U Ž0.27. y1.29U Ž0.29. 0.19 Ž0.32. Crude oil ŽM. y0.07 Ž0.15. 0.02 Ž0.03. 0.05 Ž0.15.

a The effect of a change in the price of electricity on each of the components is contained in the first row, etc. The figures in parentheses are the standard errors. U , denotes significance at 1%.

The long-run own and cross price elasticities for energy components are derived under the assumption that the total energy cost is held constant.

6

578

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

long-run own price elasticity is higher, in absolute value, than unity. This means that the demand for diesel is very responsive to a change in its own price. So, an increase in the price of diesel by 10% will decrease the amount of diesel demanded by 12.9%. Turning to long-run cross price elasticities, the results suggest that they are positive but statistically zero, apart from cross price elasticities of diesel and electricity which also exhibit a positive sign but, are statistically different from zero at the 1% level. The size of substitution between electricity and diesel is high7 with respect to the price of electricity and low with respect to the price of diesel. This means that a 5% increase in price of electricity, given the price of other inputs, will lead to a 5.6% increase in the relative share of diesel whereas a 5% increase in price of diesel, given the price of other inputs, will lead to a 0.4% increase in the relative share of electricity. Overall the results suggest that the demand for diesel, holding constant the total energy cost, is highly sensitive to price movement, while for electricity and crude oil the high standard errors make it impossible to draw any conclusion about their price responsiveness. Finally, there is no evidence for inter-energy substitution except for high level of substitutability of diesel for electricity. Next the aggregate total cost is considered in order to determine the demand for total energy. 4.2. Estimation of the total cost function Before proceeding to the estimation of the general dynamic system of share Eq. Ž13. the aggregate price index for energy has to be generated. For this reason the estimated long-run parameters from Ž14. are used as starting values for the energy cost function Ž9. and then the energy cost function Ž9. is estimated using maximum ˆ likelihood techniques. Thus, an aggregate price index Ž PE . is obtained which serves as an instrumental variable for the price of energy Ž PE . in the estimation of the dynamic system Ž13. of the shares of total cost. The test for dynamic structure of Ž13. is shown in Table 4. The results in Table 4 suggest that the general dynamic specification nests such of partial adjustment as the static at the 25% level of significance while the static specification is also nested by the general dynamic at the 10% level of significance.

Table 4 Tests of dynamic structure for the total cost share equations

2

Number of restrtions 6 7

2 0.95

2 0.90

2 0.75

Partial adjustment Static

9.187 12.173

12.592 14.067

10.644 12.017

7.841 9.037

7

This result is in accordance with the findings of a previous paper Žsee Palaskas et al., 1999a..

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

579

Table 5 Parameter estimates of translog total cost function for the Greek manufacturing with homogeneity and symmetry imposed in the long-run: 1970 1990 a Equation I Žcapital. Parameters

K

Equation II Žlabour. Coefficients 0.652U Ž0.013. 0.169U Ž0.014. y0.128U Ž0.014. y0.107U Ž0.036. 0.009U Ž0.001. 0.559U Ž0.141. 0.116U Ž0.038. y0.080UU Ž0.031. 0.012 Ž0.077. 0.962 0.002 19 3.345 5.778 Parameters

L

Coefficients 0.289U Ž0.010. 0.162U Ž0.021. y0.128U Ž0.014. 0.051UUU Ž0.027. y0.006U Ž0.001. 0.559U Ž0.141. 0.099U Ž0.029. y0.105U Ž0.031. y0.028 Ž0.059. 0.944 0.0009 19 5.149 7.766

YKK YKL

YK

YLL YLK

LY

TK

LT

K

L

KK

LL

KL

LK

KY

LY

R2 SSR OBS QŽ5. QŽ10.

R2 SSR OBS QŽ5. QŽ10.

a The numbers in parentheses are the standard errors. U , UU , UUU Indicate statistical significance at 1%, 5% and 10%, respectively. Q denotes the Box Pierce Q statistic for serial correlation in the residuals. The figures in the parentheses are the degrees of freedom for 2 statistics. The critical values at the 5% level are 11.070 and 18.307, respectively, for 5 and 10 d.f.s.

Parameter estimates using the IZEF method for the general dynamic specification are presented in Table 5. Using the parameter estimates from Ž13. and the formulas Ž15. the long-run own and cross price elasticities for the total cost function were computed. The results are tabulated in Table 6. As seen from Table 6 all own point elasticities for the aggregate factors are negative, as one would expect theoretically. However, only the capital and labour elasticities are significant at conventional levels of statistical significance. The common feature of these elasticities is that they are inelastic with the price of labour more elastic than the price elasticity of capital, as would be expected, given the gestation period required for capital investment. The estimated own demand price elasticity for aggregate energy is not statistical different from zero. An obvious interpretation of this result is that the demand for aggregate energy

580

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

**Table 6 Own and cross long-run price elasticity estimates a Capital ŽK. Capital ŽK. Labour ŽL. Energy ŽE.
**

a

Labour ŽL. 0.17U Ž0.04. y0.19U Ž0.06. 0.005 Ž0.03.

Energy ŽE. 0.14UU Ž0.07. 0.02 Ž0.10. y0.19 Ž0.17.

y0.15U Ž0.03. 0.13U Ž0.03. 0.03 Ž0.02.

The effect of a change in the price of capital on each of the other inputs is contained in the first row, etc. The figures in parentheses are the standard errors. U , UU denote significance at 1% and 5%, respectively.

remains invariant to change in its price. This might be attributed to the fact that the share of energy did not gain a dominant share in the total cost of production. Regarding the cross price elasticities, our results strongly suggest that the possibilities of substitution between capital, labour and energy in Greek manufacturing are extremely limited. This finding is also confirmed by the computed Allen-Uzawa partial elasticities of substitution. These are KL s 0.33, KE s 0.25 and LE s 0.05. It can therefore be concluded that the Greek entrepreneur is faced with difficulties in obtaining the best combination of inputs, which minimise total cost. For example an increase in the price of aggregate energy will not decrease considerably the amount of energy Žthe own price elasticity of energy is statistically zero. and as a result will not increase considerably the demand for labour Ž ELE s 0.005. and the demand for capital Ž EKE s 0.03.. Finally to complete our analysis the total own and cross price elasticity are calculated for each energy component Žsee Fuss, 1977..

Y EiYj s EiE q M jE EEE j

i , j s K,L,E.

Ž 16 .

where EiYj the cross price elasticity of demand for energy component i with respect to PE j Y held constant; EiE is the elasticity with energy cost ŽE. constant Žfrom j Y Table 3.; M jE is the defined share in the energy-sub model, and EEE is the own price elasticity of aggregate energy. The results are presented in Table 7. It is noteworthy that these total own and cross price elasticities take into account that a change in the price of an energy ˆ component also causes a change in the aggregate price energy index Ž PE .. This results in substitution between energy and other aggregate factors which affects the demand for the energy component ŽFuss, 1977.. The results in Table 7 suggest that changes in the price of energy components and to some extent in the price of aggregate energy do not affect substantially the demand for energy component, apart from diesel. It can therefore be concluded that in Greek manufacturing the level of substitution among energy components is low and is associated with a low substitution of aggregate energy for other non-energy aggregate inputs.

D.K. Christopoulos r Energy Economics 22 (2000) 569 586 Table 7 Total energy price elasticities Electricity ŽEL. Electricity ŽEL. Diesel ŽD. Crude oil ŽM. y0.11 0.07 y0.13 Diesel ŽD. 1.01 y1.30 0.11 Crude oil ŽM. y0.18 0.11 y0.03

581

4.3. Cointegration analysis Decisions on factors of production may be confounded by growth in manufacturing itself. In other words, there is a ‘spurious regression’ issue in connection with estimation of energy demand systems. A cointegration issue arises and the question is, whether or not the estimated relationships are meaningful in the long-run.8 Following the cointegration approaches of Engle and Granger Ž1987. and Philips and Ouliaris Ž1990., we have performed unit root tests on the residuals from the demand equations for the various types of energy, that is electricity, diesel and crude oil, and on the residuals from the demand equations for aggregate inputs, i.e. capital, labour and energy. Following standard practice, we have used the augmented Dickey Fuller ŽADF. test ŽDickey and Fuller, 1981.. If the ADF test indicates the presence of a unit root, demand system residuals are non-stationary implying that the estimated relationships are not structural. The results in Table 8 suggest that residuals do not contain a unit root implying that these series are I Ž0.. Therefore, there is evidence to support that the estimated relationships are indeed structural and not spurious. 4.4. Structural stability Since there are several epochs of energy prices in the data, an issue of structural stability arises. In other words, model parameters may have changed from epoch to epoch. Full-blown Chow tests involving hypotheses about structural stability of all parameters are impossible to implement, because of the small number of observations. One can, however, examine the structural stability of the constant term by testing the significance of dummy variables Žone following 1973 and one following 1979. in the estimated relationships. These dummies turn out to be insignificant and, therefore, we do not have evidence against the stability of the model Žthe computed 2 for the sub-energy model is 11.63 and for the aggregate model 10.10, while the critical value for 4 d.f. at the 1% level of statistical significance is 13.277. An independent test of model stability is provided by examining the forecasting ability of the model. If the model were subject to structural changes its forecasting performance should deteriorate. From an inspection of Figs. 1 and 2, it turns out that the dynamic forecasting performance of the model is excellent in the entire

8

This issue and the one in Section 4.4 was brought to my attention by an anonymous referee.

582 Table 8 Unit root test a Equation residual

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

Augmented Dickey Fuller test y3.197 y3.334 y2.811

Sub-energy model Electricity Diesel Crude oil Aggregate model Capital Labour Energy

y5.033 y3.752 y3.275

a The critical value of the ADF statistic Žwith no constant and no time trend. is y1.96 at the 5% level. Number of lags was selected optimally using the Schwarz criterion. The ADF regression is performed without constant term because it is known that residuals have mean zero.

sample. This provides additional evidence in favour of the model’s structural stability

5. Concluding observations The present paper investigates the demand for different types of energy, namely, electricity, diesel and crude oil, and the elasticities of substitution among energy

Fig. 1. Dynamic forecasting performance: equation of capital.

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

583

Fig. 2. Dynamic forecasting performance: equation of labour.

components and the substitution among aggregate energy and aggregate non-energy inputs Žcapital and labour., in Greek manufacturing, for the period 1970 1990. A dynamic two-stage optimisation procedure for the derived demand for each type of energy and for aggregate energy, capital and labour is adopted. In particular, it is assumed that an aggregate energy cost function exists that is weakly separable in its components. Thus, we aggregated a sub-energy model in order to construct an aggregate energy price index. In the second stage the computed instrumental ˆ variable Ž PE . from this stage is substituted in the aggregate cost function in the place of PE . In both stages the translog cost function is used under a general dynamic specification. The dynamic specification is derived using a transformation suggested in the error correction literature. The partial adjustment and the static formulations are tested against the general dynamic framework. Therefore, the dynamic specification is tested rather than arbitrarily imposed. The main characteristic of the dynamic model is that it merges the long-run steady-state theory with short-run time series properties of data and produces elasticities that are robust for policy implications. The empirical evidence can be summarised as follows: Inter-energy substitution is limited in the case of Greek manufacturing. An exception is the high degree of substitution of diesel for electricity. Also, our results provide support for inelastic demand for crude oil and electricity Žtheir computed values are close to zero. and elastic demand for diesel Ž EDD s y1.36.. Under the hypothesis that firms minimise total cost, our findings suggest that aggregate energy is not substitutable for aggregate capital and aggregate labour.

584

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

Also, there is little evidence that capital and labour substitute each other in the production process of Greek manufacturing Žthe Alien-Uzava partial elasticity of substitution is KL s 0.33.. This conclusion is also partly confirmed by a previous paper ŽChristopoulos, 1995. where a total cost function approach was used to estimate technological progress in Greek two-digit industry. For regardless of the own price elasticities for aggregate inputs capital and labour those are inelastic with the labour responsiveness to a change in its own price to be higher than the corresponding capital responsiveness of capital. The own price elasticity for aggregate energy is statistically insignificant and no conclusions can be drawn. Finally, our total own and cross price elasticities estimates suggest that an increase in the price of aggregate energy does not affect substantially the demand for energy components apart from the demand for diesel. Therefore, the degree of substitution among energy components and among aggregate energy is low except for substitution of electricity by diesel.

Acknowledgements The author wishes to acknowledge the helpful comments of Professor Panayiotis Reppas, Professor Clive Richardson, Dr Efthymios Tsionas and an anonymous referee. Any remaining errors are my own.

Appendix A

The data used in this analysis consist of annual time-series data for two-digit industry of the Greek economy employing more than 10 individuals, for the years 1970 1990. Output Ž Y . is measured in value added terms. Value added in 1970 constant prices is obtained by value added deflators. The data on value added are published in the Annual Industrial Surveys ŽAIS. of the National Statistical Service of Greece ŽNSSG. VA y Ž W q S. The price series of capital Ž PK . was calculated as PK s where NFC VA is the value added, W and S the wages and salaries, respectively, and NFC is the net fixed capital. The data on wages and salaries are published in the Annual Industrial Surveys ŽAIS. of the National Statistical Service of Greece ŽNSSG. while the deflator was taken from the National Accounts of NSSG. The data on capital stock for the period 1970 1980 were provided by Kintis Ž1986.. For the period 1981 1990 his approach was followed for the calculation of these data. All figures are expressed in 1970 constant prices. Value added deflators were used to deflate total labour compensation Žsalaries and wages. variables.

D.K. Christopoulos r Energy Economics 22 (2000) 569 586

585

Following the procedure outlined by Lianos Ž1975. and Panas Ž1986. the price W L series of labour Ž PL . was estimated by PL s where W L is the wage bill H and H is the total number of hours worked by paid workers and employees. The wage bill is expressed by means of value added deflators in 1970 constant prices. The necessary data on hours and on the number of employees were taken from the AIS of NSSG and from the ‘Year Book of Labour Statistics’ of the International Labour Office, respectively. Diesel Crude Oil Electricity: The prices series for the three types of energy were calculated by dividing expenditures by consumption in physical units for each type of energy input. The physical unit for each type of energy is expressed in equivalent tons of oil ŽTOE. Žsee Samouilidis, 1982.. All the data are expressed in 1970 constant prices and are taken from the AIS of NSSG. The deflation was made by value added deflators. The annual series for the total cost was constructed as follows: C s Value Added q Total Value of Three Types of Energy. The NSSG did not undertake an industrial survey in 1978 1979. The mean of the series was used to fill the gap for these 2 years

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