An Endogenous Growth Model à la Romer with Embodied Energy-Saving Technological Change

In this paper, we extend the Romer (1990) model in two ways. First, we include energy consumption of intermediates. Secondly, intermediates become heterogeneous due to endogenous energy saving technical change. However, aggregate effective capital is still subject to endogenous technical change of the ‘love of variety’ type, as in the original Romer model. We show that the resulting system can still generate steady state growth, but the growth rate depends negatively on the growth of real energy prices. The reason is that real energy price rises will lower the profitability of using new intermediate goods and hence the profitability of doing research, ceteris paribus. Hence, in this set-up rising real energy prices are not countered by stepping up research, but provide a negative stimulus to R&D instead. We also show that in these circumstances the introduction of an energy tax that is recycled in the form of an R&D subsidy may actually increase growth, while increasing the capital intensity of production at the same time.