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TECHNICALREPORT

ENERGYSUBSIDYREFORMINACTION

FIRM-LEVELEFFECTSOF

ENERGYPRICEINCREASES

EvidenceandInsightsfromRecentResearch

TECHNICALREPORT

ENERGYSUBSIDYREFORMINACTION

FIRM-LEVELEFFECTSOF

ENERGYPRICEINCREASES

EvidenceandInsightsfromRecentResearchJuergenAmann,DefneGencer,andDirkHeine

ABOUTESMAP

TheEnergySectorManagementAssistanceProgram(ESMAP)isapartnershipbetweenthe

WorldBank

and

over20partners

tohelplow-andmiddle-incomecountriesreducepovertyandboostgrowth

throughsustainableenergysolutions.ESMAP’sanalyticalandadvisoryservicesarefullyintegratedwithintheWorldBank’scountryfinancingandpolicydialogueintheenergysector.ThroughtheWB,ESMAP

workstoacceleratetheenergytransitionrequiredtoachieve

SustainableDevelopmentGoal7

(SDG7),whichensuresaccesstoaffordable,reliable,sustainable,andmodernenergyforall.IthelpsshapeWBstrategiesandprogramstoachievethe

WBClimateChangeActionPlan

targets.Learnmoreat:

https://

.

©2024June|InternationalBankforReconstructionandDevelopment/TheWorldBank

1818HStreetNW,Washington,DC20433

Telephone:202-473-1000;Internet:Somerightsreserved.

ABOUTTHISSERIES

Thisreportispartofthe“EnergySubsidyReforminAction”seriesproducedbytheESMAPEnergy

SubsidyReformFacility,withtheobjectiveofdrawinginsightsfromrecentexperiencesandemerging

approachesrelatedtoreformofenergysubsidiesindevelopingcountries.Theseriesincludesissue-

specificreportsfromvariousrelevantdomainssuchasenergysectorreform,macroeconomicandfiscalpolicy,carbonpricing,povertyanddistributionalanalysis,socialprotection,politicaleconomy,and

communications.

RightsandPermissions

Thematerialinthisworkissubjecttocopyright.BecausetheWorldBankencouragesdisseminationof

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/licenses/by/3.0/igo.UndertheCreativeCommonsAttributionlicense,youarefreetocopy,distribute,transmit,andadaptthiswork,includingforcommercialpurposes,underthefollowingconditions:

Attribution—JuergenAmann,DefneGencer,andDirkHeine.2024.Firm-LevelEffectsofEnergyPriceIncreases:EvidenceandInsightsfromRecentResearch.EnergySubsidyReforminActionSeries.ESMAPTechnicalReport.Washington,DC:WorldBank.License:CreativeCommonsAttributionCCBY3.0IGO.

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ProductionCredits

Designer|LauraC

.

Johnson

Contents

Acknowledgmentsv

ExecutiveSummaryvi

1

Introductionxx

1.1.BackgroundandFirstPrinciples2

1.2.WhatDoMicrodataSayaboutFirm-LevelImpactsofEnergyPriceChanges?4

1.3.Firm-LevelResponseMechanismstoPolicy-InducedEnergyPriceChanges5

2

ASummaryoftheLiterature12

2.1.Pass-Through15

2.2.Absorption17

2.3.Substitution22

2.4.InnovationandProductivity24

3

TheImportanceofCarefulPolicyDesign32

4

AreasforFutureWork34

References37

CONTENTSiii

ListofFigures

FIGURE1.1Firm-LevelResponseFramework6

FIGURE2.1ScopeandCoverageofReview14

ivLISTOFFIGURES

Acknowledgments

ThisreportwaspreparedbystaffandconsultantsoftheWorldBankandtheEnergySectorManagementAssistanceProgram(ESMAP).TheunderlyinganalysiswasfundedbyESMAP’sEnergySubsidyReformFacility.ThemainauthorsareJuergenAmann,DefneGencer,andDirkHeine.

Theauthorswouldliketoacknowledgecolleagueswhowereinvolvedindifferentstagesofthestudy,inparticularMinALee,NoeReidt,andTanjaLarsen.Theproductionofthe

reportbenefitedfromsupportfromSherrieBrownforeditingservices,LauraJohnsonfordesign,andHeatherAustinforpublications.

TheauthorsareparticularlygratefultoMassimilianoCaliandPaoloAgnolucci,whoservedaspeerreviewersandwhoseinputsandadvicehelpedstrengthentheanalysisandthe

finalreport.Anyerrorsofinterpretationarethesoleresponsibilityoftheauthors.

TheauthorswouldliketorecognizeDemetriosPapathanasiou,GlobalDirectorforEnergyandExtractives,andChandrasekarGovindarajalu,ManagerofESMAP,forprovidingtheguidance,encouragement,andresourcesforthiswork.

ACKNOWLEDGMENTSv

ExecutiveSummary

Energyisacriticalfactorofproductionforfirms,andenergysubsidiesencourage

excessiveandinefficientenergyuse.Whenthegovernmentsubsidizesanyspecific

input,firms’decisionsregardingtheoptimalmixofinputfactorstoproduceoutputare

distorted,whichcanreduceeconomicefficiency:reducingthepriceofoneparticularinputencouragesfirmstousemoreofitperunitofoutput,distortingboththeamountandthewayagoodisproduced.1Reformingenergysubsidiescanhelpaddressdistortionsand

misplacedincentivesforfirmstooveruseenergyandcanencouragefirmstoallocateproductioninputsmoreefficiently.

Thecomplextopicofhowfirmsareaffectedbyandrespondtopolicy-inducedenergypriceincreaseshadnotbeenextensivelyexploredinresearchandtheacademic

literatureuntilrecently.Inthepastfewyears,moreevidenceandstudiesexploringthissubjecthavebecomeavailable.Tobetterunderstandemergingknowledgeandevidenceinthisfield,thisreportreviewsaselectionoftheacademicandempiricalliteratureonthe

firm-levelimpactsofenergypriceincreasespublishedfrom2010onward.

Therecentempiricalliteratureshowsthattheimpactofenergypriceincreasesandfirms’responsestothemdependonmultiplefactors.Thesefactorsincludethefirm’senergydependence,themagnitudeofthechangesinpricelevels,andtheavailabilityof

optionsthefirmcanusetoadaptandreduceenergyconsumptioninresponsetoprice

signals.Firmshaveseveralresponsemechanismsattheirdisposalwhenconfrontedwithpolicy-drivenenergypriceincreases.Firmstypicallynavigatepolicy-inducedenergyprice

changesby(1)passingthepriceincreaseontocustomers;(2)absorbingthepriceincrease;(3)replacingoneenergycarrier2withothers,orchangingtherelativesharesofenergyandotherinputs;or(4)usingfirm-levelcapacitythatdrivesinnovationandproductivity.

Theempiricalliteratureidentifiessubstantialcostpass-throughbyfirmsinresponsetoenergypriceincreases.Researchconsistentlydemonstratesthatincreasedcosts

stemmingfromenergypricereformsareoftenpassedontoconsumers.Thisdynamic

interplayunderscoresthepotentialramificationsforoverallconsumerwelfare.Cost

pass-throughisidentifiedacrossvariouslevelsofanalysis,includingsectoral,firm-specific,andcommodity-basedassessments,revealingintricatelinkswithinproductionnetworks.

1.Energysubsidiesareinputsubsidiesandtendtobemoredistortionarythanoutputsubsidies,whichencouragefirmsto

producemoreoftheiroutputsbyusinganycombinationofinputsthatthefirmchoosesandwillonlydistorttheamount

produced.Sometimes,thetwocategoriescanbecombined;outputsubsidiesforupstreamproducersinthesupplychainforaspecificgoodcanbecomeinputsubsidiesfordownstreamproducers.

2.Anenergycarriercanbedefinedasa“substanceorphenomenonthatcanbeusedtoproducemechanicalworkorheatortooperatechemicalorphysicalprocesses”(ISO13600:1997).Intheenergyvaluechain,thecarriersaretheintermediatestep

betweenprimaryenergysources,suchascrudeoilandcoal,andend-useapplications,suchaslighting,refrigeration,orheating.Examplesincludeelectricity;solid,liquid,orgaseousfuels;andheat.

viEXECUTIVESUMMARY

Furthermore,dataconstraintsatthefirmlevelcomplicatetheunderstandingofcapacity-relatedresponsepatterns,particularlywithinthecontextofdevelopingeconomies.

Firms’tendencytoabsorbpolicy-inducedenergypriceincreasesvariesdependingontheircharacteristicsandsectoralattributes.Notsurprisingly,businessesinsectorsthatusesubstantialamountsofenergytendtoreactthemostwhenpricesgoup.Although

thereisnoconclusiveevidenceforfirmexitorsignificantaggregateemploymentlossinresponsetoenergypriceincreases,theevidencedoessuggestpotentialshiftsinthe

workforcewithinspecificsectors,highlightingtheneedforcarefulpolicyresponses.

Theliteraturepresentscompellingevidenceofsubstantialsubstitutionamong

variousproductioninputs,notablybetweenenergyandlaborinputsandamong

differentenergysources.Thenecessarydataforanalyzinginterfuelsubstitutionrequirescomprehensiveinformationondiverseenergyinputsusedbyfirms,whichisnotcommonlyavailableinstandardfirm-leveldatasets.Consequently,empiricalinsightsintointerfuel

substitutionmechanismsremainrelativelyscarce.Nevertheless,theoverallpictureemerg-ingfromtheliteraturehighlightswidespreadsubstitution.Particularlynoteworthyare

discernibledisparitiesintheabilityoffirmstosubstitutebetweendifferentfossilfuels,inparticularbetweencoalandgas,butalsobetweenfuelsandelectricity.

FIRM-LEVELEFFECTSOFENERGYPRICEINCREASESvii

Finally,recentresearchoffersinsightsintotherelationshipbetweengovernment

intervention—energypriceinterventioninparticular—andinnovation.TheempiricalfieldfindsbroadsupportfortheweakformofthePorterhypothesis,inwhichpolicy

interventionstriggerinnovation.Inturn,theresearchdoesnotappeartoofferconclusivesupportforthestrongPorterhypothesis,accordingtowhichenvironmentalpolicyinnova-tionsspurfirmcompetitiveness,productivitygrowth,andprofitability.

Overall,researchdoesofferevidencethatfirms’responsestorisingenergyprices

varydependingontheircharacteristics,withfirmsizebeingaparticularlyimportantfactor.Anotherhighlyrelevantaspectismanagerialquality,giventhatwell-managedandenvironmentallyconsciousfirmsaretypicallymoreresponsiveandadjusttochangesin

energypricesmoresuccessfully.Finally,firm-levelresponsestoenergypriceincreasesvarybyenergysourceorcarrier:althoughfirmshavebeenobservedtousePorter-typeadjust-mentmechanismsinresponsetofossilfuelpriceincreases,electricitypriceincreasesaretypicallyfoundtohavemuchmoresignificantfirm-levelimpacts,withrelativelylimited

optionsforadjustment.

Onaggregate,evidenceandanalysesfromrecentresearchindicatethatenergypriceincreasesarenotnecessarilydetrimentaltofirmsastheyhavemultipleresponse

mechanismsattheirdisposalwithwhichtonavigatethem.First,notallfirmsmaybesimilarlyaffectedbypolicy-inducedpricechanges;forexample,smallerfirmsandthosein

viiiEXECUTIVESUMMARY

moreenergy-intensivesectorstendtobemoresubstantiallyaffectedbysuchpolicy

changes.Second,fromapolicyperspective,someoftheresponsesbyfirmsmaybemoredesirablethanothers.Forexample,iffirmscanpassthroughallenergypriceincreasestohouseholds,thewelfare,socioeconomic,andenvironmentaloutcomesfromsuchchangesmayrequirefurtherconsiderationthanwhenfirmsinsteadresorttocleanerandmore

modernproductionprocesses.Athirdandrelatedpointisthatpolicyandregulatory

choicesbygovernmentscanmitigateimpactsonfirmsandinfluencetheresponses

deployedbyfirms.Indeed,afewstudiesshowthattheimpactofenergypriceincreasesonfirmscanbereducediftheseincreasesareaccompaniedbypolicymeasuresandgovern-mentspendingthatsupportinnovationandproductivityorthatarefavorabletothe

privatesectorandbusinessenvironment.Suchmeasuresmayincludethoseaimedat

reducingcorporatetaxes,issuingvoucherstoconsumers,orinvestinginpublicgoods

crucialforinnovation,productivity,andefficiency.Successfullyaddressingthesechallengesrequiresanuancedunderstandingofmarketconditionsandtailoredpolicyapproaches,

underscoredbyfurtherinvestigationintofirm-leveldata.

Futureworkonthefirm-levelimpactsofenergypriceincreasesandresponsestothemcouldfocusongatheringadditionalevidenceanddocumentingnovel

approaches.Thereviewofrecentresearchpointedtoseveraltopicsthatmaybeofinter-est,including(1)conductingmoregranularanalysesoffirmresponses,(2)leveragingnoveldataandmethodologiestodevelopamorecomprehensiveunderstandingoftheresponsemechanisms(3)ensuringthesustainabilityandinclusivenessofpoliciesthatfocusontheuniquechallengesandopportunitiesfacedbyfirmsindevelopingcountries,(4)exploringtheeffectivenessofvariouspolicyincentivesandtargetedmitigation,and(5)focusingontheuseoffiscalsavingsfromenergysubsidyreformsforimprovingfirmandsectorleveloutcomesandbroadeningthescopeoftheimpacttogreenpoliciesovertime.

FIRM-LEVELEFFECTSOFENERGYPRICEINCREASESix

ONE

Introduction

Energyisanessentialproductioninputforfirms.Inmarket-basedeconomies,afirm’sobjectiveistomaximizeprofitsbycombiningenergywithotherinputs,suchaslabor,

capital,andnaturalresources,toproducegoodsandservices.Thepricesofthesedifferentproductioninputsdeterminehowmuchofeachresourcefirmsuse.1Governmentsubsi-

diestoanyspecificinputdistortfirms’calculusindeterminingtheoptimalmixofinputfactorsandencouragethemtousemoreofthesubsidizedinputperunitofoutput.Thisaltersboththeamountandthewayagoodisproducedandleadstooveralleconomicinefficiency.

Governmentsaroundtheworldhavebeensubsidizingtheproductionandconsump-tionofenergyfordecades.2Themainargumentsinfavorofenergysubsidiestendto

includeacombinationofshieldingdomesticproducersfromglobalfuelpricevolatilityandmakingcheapenergyavailabletolower-incomehouseholds,therebyservingasaredistrib-utivemeasure.Althoughtheremaybebenefitsconferredbyenergysubsidiestocertain

segmentsoftheeconomy,theyalsocomewithsignificantramificationsforpublic

resources(Kojima,Bacon,andTrimble2014),firms,households,andtheenvironment

(CouhardeandMouhoud2020;Clementsetal.2013;InchausteandVictor2017;Kojima,

Bacon,andTrimble2014).Artificiallylowenergypricescanleadtoinefficientandexcessiveenergyconsumption(Coadyetal.2017)andslowdowninnovation(Aghionetal.2016;Ley,Stucki,andWoerte2016).

Byreformingenergysubsidies,governmentscanreducesomeofthedistortions

affectinghowfirmsmixproductioninputstogenerateoutput.Energyprice

increases—notonlythoseresultingfromsubsidyreformsbutalsothosethataretheresultofotherpriceandnonpricepolicies—canprovideincentivestofirmstoallocateproductionfactorsmoreefficiently.Energypriceincreasesmayaffectfirmstovaryingdegrees,andthemagnitudeandchannelofimpactdependonvariousfactors,includingthefirm’senergy

dependence,theextentofthechangesinpricelevels,andtheavailabilityofoptionsforthefirmtoadaptandreduceenergyconsumptioninresponsetopricesignals.

Althoughthereisextensiveacademicliteratureandpolicydebateabouttheimpactsofenergysubsidiesandtheirreformfocusingonhouseholds,muchmorelimited

researchandevidencehadbeenavailableonfirm-leveleffects.From2010onward,therehasbeenagrowingamountofresearchexaminingthevariouswaysinwhichfirmsareaffectedbyenergypricechanges.Theserecentpapersexplorehowandtheextenttowhichenergypricechangesaffectfirmsofdifferentsizes,capacities,andsetupsacrossvarioussectors.

Thispaperreviewsrecentresearchonthefirm-levelimpactsofenergyprice

increases,documentsemergingthemesandinsights,andoffersrecommendationsfordimensionsthatcanbeconsideredinfuturework.Theobjectiveofthereviewisto

1.Akeyideaineconomicsisthatofthemarginalrateoftechnicalsubstitution,whichexpressestheideathatfirmscanproducetheirgoodsandservicesusingdifferentmethodsandcombinationsofproductioninputs.Afirmdecideshowtocombinethevariousinputsbasedontheirrespectiveprices,withtheobjectiveofmaximizingprofits.

2.Forasummaryoffossilfuelsubsidyreformsindevelopingcountries,seeCouhardeandMouhoud(2020).

FIRM-LEVELEFFECTSOFENERGYPRICEINCREASES1

strengthentheunderstandingoftheimpactofpolicy-inducedenergysubsidychangesonfirmsbyreviewingrecentadvancesintheempiricalliterature.Thereviewfocusedon

empirical,firm-levelstudiesindevelopinganddevelopedcountries.RelevantarticleswereidentifiedthroughtargetedkeywordsearchesonScopus,WebofScience,andGoogle

Scholar,focusingonpeer-reviewedworkandwell-establishedworkingpaperseriespub-

lishedafter2010withanempirical,typicallyfirm-level,foundation.Thereviewedpapers

werecategorizedfollowingaframeworkoffirm-levelresponsemechanismsthatwas

developedbasedondifferentconceptualizationsinthefield.Inadditiontoprovidingan

empiricalsynthesisoffirm-levelresponsemechanisms,thereviewfocusesonheterogene-itiesinfirm-levelresponsepatternstoenergypricehikes.Thereviewconcludeswith

recommendationsforfutureempiricalwork,dealingwithbothcountrysettingandtypesofanalyses.

1.1.BackgroundandFirstPrinciples

Energypricesubsidies,whichartificiallylowertheenergycostsfacedbyconsumers,constituteinputsubsidiesforfirmsthatrelyonenergyasaninputfortheirproduc-tion.3Suchsubsidiesreducethepriceofaspecificinputfactoranddecreasetheircosts

relativetothoseofotherinputs,whichencouragesfirmstousemoreofthesubsidized

productionfactor.Furthermore,giventhelowerpostsubsidycostsofinputs,firmscannowgeneratemoreoutputgiventhesameproductioncosts.Inotherwords,inputsubsidies

distortboththeamountofgoodsproducedandthewaytheyareproduced.4Artificially

lowerenergypricesmaynotonlyleadtoexcessiveconsumptionandinhibitenergyeffi-

ciency,theymayalsocreatesuboptimalpath-dependence:lowenergypricesmaydiscour-ageinvestmentinmoreenergy-efficientcapitalandnewtechnology,whichultimatelymayaffectafirm’scompetitivenessandalsounderminetheutilizationofandresearchinto

technologiesthatcouldhavetakenplaceinamorecost-transparentenvironment(Ley,Stucki,andWoerter2016).

Reformingenergysubsidiescanaddressthedistortions,misplacedincentives,and

costmisalignmentbetweenproductioninputscausedbythosesubsidies,andrestoretransparency.Underthebasicassumptionofmarket-basedeconomies,reformingenergysubsidieswouldimprovefirmefficiency.However,thereareseveralpotentialimpactsand

3.Foracomprehensivediscussionofenergysubsidies,seeKojima(2017).

4.Ingeneral,subsidiescanbebroadlycategorizedasinputsubsidiesandoutputsubsidies(SchwartzandClements1999).

Differentfrominputsubsidies,outputsubsidiesprovideafinancialrewardforoutputs,therebyencouragingafirmtoproduce

more,usinganycombinationofinputsthatthefirmmanagerchooses.Forexample,asubsidyperunitofcoalconsumedby

powerplantsisaninputsubsidy,whereasasubsidyperunitofelectricityproducedisanoutputsubsidy.Whileinputsubsidies

distortboththeamountandthewaygoodsareproduced,outputsubsidiesonlydistorttheamountproduced.Sometimes,the

twocategoriesofsubsidiescanoverlap—outputsubsidiesforupstreamproducersinagood’ssupplychaincanbecomeinput

subsidiesfordownstreamproducers(OECD2019a),forexample,whenasubsidypermegawatthourofelectricityprovidedtothepowersectorreducesthepriceofelectricity,akeyinputforindustrialconsumers.Similarly,supportingupstreamindustry

development,forexample,bydevelopingmanufacturingcapacities,canincreasedemandforthedownstreamsegmentofthevaluechain(OECD2019b).

2INTRODUCTION

constraintsthatneedtobeconsidered.First,eventhoughenergysubsidiescreatelarge

distortionsintheeconomy,removingthemcaninvolvetransitionrisksthatneedtobe

managedcarefully.Simplyput,ifasubsidyregimehasbeeninplaceforalongtime,firmswillhaveadaptedtothesedistortions,andarapidmovetohigherenergypricescancausedisruptions,overwhelmfirmswithmanagerialorliquidityconstraints,orleadtostrandingofenergy-intensiveassets.Moreover,ifmultiplecountrieswhosefirmsarecompetinginthesamegoodsmarketsprovideenergysubsidies,increasingenergyinputcostscanriskputtingsomeofthefirmsatadisadvantage.Anincreaseinenergyinputcostscouldalsocontributetoacontractioninoutputinthatsector,evenwhentherearesomeefficiencygainsduetooperationalresponsestohigherenergyprices.Theaggregateeffectofsubsi-diesdependsonthetypeoffirmdirectlyaffectedbythesubsidyandthoseindirectly

affectedbythesubsidythroughproductmarketcompetition(Rotemberg2019).

Firmsvaryintheirabilitytorespondtoincreasingenergyprices,andtheirabilitytodosomaybetiedtofirmcharacteristicssuchassize,age,orsector.Eventhough

energysubsidiesmaybeaninefficientwaytosupportfirms,theireliminationcanbe

detrimentalforfirmsthatarenotinapositiontorespondquicklyandefficientlytosuch

policychanges.Consequently,energysubsidyreformsneedtobebasedonanunderstand-ingofthevariationinthepotentialfirm-levelimpactsandresponsesandanassessmentoftheimpactofspecificpolicyoptionsontheeconomy,markets,andfirms.

Animportantconsiderationishowthegovernmentusesthefiscalresourcesthat

wouldbefreedupfromreformingenergysubsidies.Governmentspendingdecisions

thatarebeneficialfortheprivatesectorandmarketdevelopment,andfiscalresources

directedtowardtheseobjectivesinsteadofbeingusedtofinanceenergysubsidies,can

contributetopositiveeffectsforfirms.Examplesofthetypesof“revenuerecycling”actionsthatcanbebeneficialtofirmsincludeloweringtaxesontheoutputofthefirms’production(corporateandpersonalincometaxes),substitutingoutput-basedsupport(including

voucherstoconsumersforthefirms’output)forinputsubsidies,andprovidingcash

transfersorothersocialassistancetoconsumerswithresultingpositiveincomeeffectsfordemandorimprovingtheprovisionofthepublicgood(Becketal.2015;Beiser-McGrath

andBernauer2019;LiuandLu2015).Subsidiesthatarefinancedthroughdirecttaxesonnonenergyinputsofproductionsuchaslabordistortfirmdecisionstwice:theenergy

subsidyencouragesproductionprocessestobemoreenergy-intensivethanwhatwould

havebeenthefreemarketoutcome,andlabortaxestofinancethesubsidymakeproduc-tionlesslabor-intensive.Laborcanalsobesubstitutedforindirectly:inmanyindustries,

higherenergyintensitycorrelateswithgreateruseofmachinery(see,forexample,Sahu

andNarayanan2009),whichcanmeanthatincreasedenergysubsidiesraiseincentivesforfirmstomechanize,furtherreducingemployment.Inthesesituations,firmsandworkerscanbenefitifthegovernmentreplacesenergysubsidieswithlowertaxes,especiallyon

labor.However,thispotentialbenefitfromlowertaxesonemploymentandfirmsismostlyshownatthemacroeconomiclevel;examplesofrelevantpapersincludeHeineandBlack(2019)andSchoder(2021).

FIRM-LEVELEFFECTSOFENERGYPRICEINCREASES3

Whilethereareexamplesoftheimpactsoffiscalpolicytoolsontheprivatesectorintheaggregate,muchlessinformationisavailableonwhathappensatthefirmlevelinresponsetothesepolicies.Eventhoughgovernmentshaveallocatedmorethan70

percentofrevenuesgeneratedthroughvariousemissionstradingsystems(ETS)and

carbontaxestoeithergreenspending,privaterevenues,andgovernmentgeneralbudgets(CarlandFedor2016),studiesisolatingthefirm-leveleffe