A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Cai, Yifei; Wu, Yanrui Working Paper Time-varying interactions between geopolitical risks and renewable energy consumption ADBI Working Paper Series, No. 1089 Provided in Cooperation with: Asian Development Bank Institute (ADBI), Tokyo Suggested Citation: Cai, Yifei; Wu, Yanrui (2020) : Time-varying interactions between geopolitical risks and renewable energy consumption, ADBI Working Paper Series, No. 1089, Asian Development Bank Institute (ADBI), Tokyo This Version is available at: http://hdl.handle.net/10419/238446 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by-nc-nd/3.0/igo/ www.econstor.eu ADBI Working Paper Series TIME-VARYING INTERACTIONS BETWEEN GEOPOLITICAL RISKS AND RENEWABLE ENERGY CONSUMPTION Yifei Cai and Yanrui Wu No. 1089 March 2020 Asian Development Bank Institute Yifei Cai is a PhD candidate, and Yanrui Wu is a professor and head of the Department of Economics Business School, University of Western Australia. The views expressed in this paper are the views of the author and do not necessarily reflect the views or policies of ADBI, ADB, its Board of Directors, or the governments they represent. ADBI does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use. Terminology used may not necessarily be consistent with ADB official terms. Working papers are subject to formal revision and correction before they are finalized and considered published. The Working Paper series is a continuation of the formerly named Discussion Paper series; the numbering of the papers continued without interruption or change. ADBI’s working papers reflect initial ideas on a topic and are posted online for discussion. Some working papers may develop into other forms of publication. In this report, “$” refers to United States dollars. Suggested citation: Cai, Y. and Y. Wu. 2020. Time-Varying Interactions between Geopolitical Risks and Renewable Energy Consumption. ADBI Working Paper 1089. Tokyo: Asian Development Bank Institute. Available: https://www.adb.org/publications/time-varying-interactions- between-geopolitical-risks-renewable-energy-consumption Please contact the authors for information about this paper. Email: [email protected], [email protected] Work on this paper is supported by an Australian Government Research Training Program (RTP) scholarship, a University Postgraduate Award (UPA) and Asian Development Bank Institute. The authors acknowledge the helpful comments from Youngho Chang and other participants of an ADBI workshop (Tokyo, November 2019). Asian Development Bank Institute Kasumigaseki Building, 8th Floor 3-2-5 Kasumigaseki, Chiyoda-ku Tokyo 100-6008, Japan Tel: +81-3-3593-5500 Fax: +81-3-3593-5571 URL: www.adbi.org E-mail: [email protected] © 2020 Asian Development Bank Institute ADBI Working Paper 1089 Cai and Wu Abstract This study utilizes a time-varying parameter Bayesian vector autoregressive model to investigate the dynamic interactions between geopolitical risk (GPR) and renewable energy consumption growth (RECG). The identification strategy is flexible to accommodate cases both with and without sign restrictions. It is shown that GPR shocks have positive impacts on RECG over time. In contrast, RECG shocks decrease GPR in the whole sample period. These results show that renewable energy is a useful tool to reduce geopolitical risks. Meanwhile, the increasing geopolitical risks tend to augment renewable energy consumption. We also provide the responses at different time horizons and during particular geopolitical events. The estimating results are robust when industrial production growth is used as a control variable. Lastly, several implications for economic policy making are discussed. Keywords: renewable energy consumption, geopolitical risk, time-varying parameter VAR model, robustness checks JEL Classification: Q20, D80, C11 ADBI Working Paper 1089 Cai and Wu Contents 1. INTRODUCTION ......................................................................................................... 1 2. LITERATURE REVIEW ............................................................................................... 2 3. DATA AND ECONOMETRIC MODELS ...................................................................... 4 3.1 Data ................................................................................................................. 4 3.2 Models ............................................................................................................. 4 4. RESULTS .................................................................................................................... 7 4.1 Results of Standard VAR Model ...................................................................... 7 4.2 Results of TVP-BVAR Model with Sign Restrictions ....................................... 9 4.3 Results of TVP-BVAR Model with Sign Restrictions Given RECG Shock ..... 13 5. ROBUSTNESS CHECKS .......................................................................................... 15 6. CONCLUSIONS ........................................................................................................ 17 REFERENCES ..................................................................................................................... 19 APPENDIX ............................................................................................................................ 21 ADBI Working Paper 1089 Cai and Wu 1. INTRODUCTION In recent decades, oil-rich regions such as the Persian Gulf have become the most geopolitically sensitive area. Major geopolitical events such as the Gulf War, Kuwait invasion, and Iraq invasion all occurred in this area. Meanwhile, the gas crisis between the Russian Federation and Ukraine poses a geopolitical challenge to the world in terms of energy security. Moreover, other geopolitical events such as the 9/11 terrorist attack, Madrid bombing, London bombing, Iranian nuclear tensions, ISIS escalation, and the Democratic People’s Republic of Korea’s nuclear issue all pose a threat to economic stability and could drive the next round of energy transition. Some resource-rich countries even utilize oil and gas supplies as geopolitical weapons to achieve their political goals. Although oil and gas play key roles in supporting growth, the rapid growth of renewable energy is gaining greater attention. Renewable energy is a potential substitute for fossil fuels and is viewed as the main support for cleaner growth. Since 2018, the share of renewable energy consumption in the US has doubled, as coal’s share declined in the same period from 48% to 30%. Although President Donald Trump signals a desire to cut funding for renewable energy and energy efficiency programs, renewable energy consumption is still surging due to the market forces. Besides, 18% of all electricity in the US was produced by renewable sources in 2017. According to a comprehensive study by NREL (2020), renewable energy will generate most of the electricity in the United States (US) by 2050. The driving forces are the development of technology and decreasing cost. Unlike oil and gas, renewable energy is less dependent on rare earth elements. The key rare elements for renewable energy include neodymium, praseodymium, and dysprosium. Overland (2019) shows that these materials only account for less than 2% of wind turbines which use permanent magnets in the US. Other earth elements for renewable energy include lithium, cobalt (lithium ion battery technology), and copper (electric turbines), but these materials are not rare in the earth’s crust. For instance, lithium is widely spread in countries including Australia, the People’s Republic of China, the Russian Federation, and the US. The common materials required for renewable energy determine that it is less likely to be a source used as a geopolitical weapon. To some extent, renewable energy, as a substitute for oil and gas, can be a useful tool to alleviate the world’s current geopolitical stress. Overland (2019) argues that the nexus between geopolitical risk and renewable energy represents a new research direction. He suggests that the interaction between the two factors should be modeled as a changing process, because both geopolitical risk and renewable energy have changed dramatically in recent decades. However, existing studies