The Income Share of Energy and Substitution : A Macroeconomic Approach

As the atmospheric concentration of CO2 emissions has grown to record levels, calls have grown for governments to make steeper emissions cuts, requiring to reduce an economy's use of fossil energy dramatically. Meanwhile, in the U.S., fossil energy still met 80 percent of the total energy demand as of 2019. This paper examines U.S. energy dependence, measured by its factor share, using a simple neoclassical framework in a systematic way. We find that with empirically plausible differences in substitution elasticities, particularly with a time-varying substitution elasticity between equipment capital and energy, changes in observed factor inputs can account for the variation in the income share of energy. Our analysis suggests that energy-saving technical change may simply be serving as a proxy for capital-energy substitutability. We also use our framework to think about the future. Substitution possibilities among different factor inputs can allow for a decline in the factor share of energy in the long-run