Development of a two-sector model with an extended energy sector and application to Portugal (1960-2014)

In basic economic growth models, energy is neglected as a production factor, and output is generated from capital and labor in a single-sector process, with most of growth attributed to an exogenous residual. However, alternative approaches argue for a multi-sector system in which the major contribution to growth comes from increased efficiency in the conversion of energy to more productive forms. In this work we develop a two-sector model for the economy, featuring an extended energy sector, including all primary-to-final (energy industries) and final-to-useful (end-use devices) exergy conversion processes. Exergy is a thermodynamics concept, accounting for the potential of energy to perform work. Empirical application of the model for a single country (Portugal) requires decomposition and reclassification of national accounts and energy balances, to match empirical data with the model’s variables. Obtained estimates for the price of useful exergy (an intermediate product) facilitate the construction of gross output measures for more accurate growth accounting. Evidence suggests that declining useful exergy prices act as an engine of growth, as previously suggested in the literature. Additionally, useful exergy and capital inputs to non-energy related production act as complements while capital productivity in useful exergy generation declines slightly in the past decade.