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Contribution to the Third International Conference on Small Island Developing States (SIDS)

1 – 4 September 2014 Apia, Samoa

EXECUTIVE SUMMARY

Abstract

Small-island developing states (SIDS) face significant stress from climate change without having made appreciable contributions to anthropogenic emissions. The current pace of international climate action exacerbates the vulnerabilities of SIDS. SIDS must therefore develop partnerships to marshal domestic resources to fund climate adaptation projects. Renewable energy investments have the potential to displace expensive fuel imports that continually deplete foreign currency reserves and adversely affect macroeconomic performance through impacts on net exports. Due to the potential for substantial foreign currency savings, renewable energy investment represents a high-impact opportunity for sustainable development. Using Bloomberg New Energy Finance Database and World Bank World Development Indicators, this paper demonstrates through statistical regression that SIDS have garnered and can expect to continue to garner positive and significant shocks to macroeconomic performance, particularly GDP, through renewable energy investment.  

SIDS and Climate Change

Geographic and economic factors combine to make islands uniquely vulnerable to climate change. Individually, SIDS have contributed relatively little to anthropogenic sources of global climate change. In aggregate, however, SIDS produced as much CO2 from energy use as France in 2011 or about 1.1% of the global total . The current pace of international climate action exacerbates the vulnerabilities of SIDS. Working Group II’s contribution on to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change (IPCC) reconfirmed that islands face variable climate-related risk drivers including sea-level rise, cyclones, increasing air and surface temperatures, and changing rainfall patterns. Hazards can contribute to a “loss of adaptive capacity and ecosystem services critical to lives and livelihoods in small islands.”

Fossil Fuel Dependence in SIDS

Fossil fuel imports impede macroeconomic performance in SIDS. SIDS spent at least US$ 137 billion on fossil fuel imports in 2012. Most island countries remain almost entirely dependent on imported fossil fuels – particularly petroleum products – for electricity and transport. Since 2000, demand has increased by approximately 700%. Fuel imports in 2012 ranged from the equivalent of US$ 600 to US$ 3500 for every man, woman, and child living in small island economies.

SIDs Fuel Import

Further, as increasing shares of the global petroleum supply are sourced through relatively expensive “unconventional” means – for example through hydraulic fracturing or tar sands – prices are projected to increase, reinforced by growing demand in the developing world. Base-case projections for 2040 oil prices are currently estimated at US$ 141, a more than 25% increase over 2012 prices.

Due to the inherent importance of the energy sector in national economies, high and volatile prices for fuels on international markets present systemic challenges for island economies – many of which are heavily indebted or rely on generous financing terms under international agreements such as PetroCaribe, which could destabilize. As such, islands are energy insecure and are exposed to variable year-to-year energy costs, which impede policy-planning processes, and pose risks to islands’ balance of payments and solvency.

SIDS and Renewable Energy

The deployment of renewable energy in small island economies remains low. Values for renewable energy generation ranged from 0% in over a dozen island economies to 74% in Belize. Renewable energy generated on average, only 13% of electricity in a given island economy. Nevertheless, renewable energy generation targets are strengthening. This may reflect policymakers’ growing confidence in the feasibility or viability of new renewable energy deployments.

Challenges faced in attracting private sector investments or in forming public-private partnerships are political, economic, and logistical in nature. For instance, the International Renewable Energy Agency’s (IRENA) August 2014 report, Renewable Islands: Settings for Success, argued that combinations of political prioritization, open markets, technical planning, and capacity building have catalyzed renewable energy investment inflows in Cabo Verde, Cyprus, Fiji, and Samoa. The report also emphasized that renewable energy projects were untaken in part to curtail high retail electricity rates. As the upper range of retail electricity prices in SIDS exceeds 40 U.S. cents per kilowatt-hour, and as many renewable energy technologies become increasingly affordable (See Appendices A7-A9), renewable energy deployment will become an increasingly attractive option for replacing aging energy infrastructure in SIDS.

The Study: Method, Data, and Analysis

Using panel data from Bloomberg New Energy Finance Database and World Bank DataBank World Development Indicators from 2000 to 2013, this study regressed the relationship between renewable energy investments in SIDS with macroeconomic indicators using fixed effects modeling. The final dataset excluded projects in planning phases, and combined all renewable energy investments for a given country in a given year into a single observation. There were 38 observations spanning 16 island economies totaling US$ 6.24 billion in renewable energy investments since 2000.

Investments included solar, wind, geothermal, biofuels, biomass and waste, and small-scale hydroelectric projects. Because baseload technology categories like geothermal, ocean kinetic, and ocean thermal represented low or non-existent portions of the dataset, our model could ultimately underestimate the potential macroeconomic benefits from renewable energy investments.

Figure 2Figure 2: Technology breakdown of renewable energy investments in the sample set as a percentage of the total RE investment amount for 16 SIDS (the number for which there was sufficient data to include in the study) from 2000-2013. Source: Calculations based on data from Bloomberg New Energy Finance Database.Table 

The Study: Results

This study could detect no statistically significant macroeconomic benefit from fossil fuel imports in the focal island economies since 2000. This was as expected since fuel imports may offset productivity benefits by degrading foreign currency reserves and current accounts, which affect myriad aspects of economic output. In contrast, however, and as expected, renewable energy is making significant and positive impacts on islands’ macroeconomic performance, even as aggregate deployment remains low. In fact, renewable energy is associated with an outsized catalyzing impact on GDP: the model’s results affirm that for every 1% increase in renewable energy funding in SIDS, GDP grew by 0.0492%. Although this study is limited by the sample size (improvement would require both more investment and consistent reporting) and the number of control variables (many of which also necessitate more consistent data reporting), this analysis provides valuable insight on the effect of renewable energy investment on macroeconomic performance.

Small Island Developing States

Countries 1

Countries 2

Note: This paper is divided into two sections. The first section presents background material on as many SIDS for which data is available. In the second section, however, this paper explicates an empirical study. Due to the data requirements of this empirical analysis not all SIDS were able to be included. The 16 SIDS that are highlighted were included in the study; the others were omitted due to missing or non-existent renewable energy investment data or macroeconomic data.

 

SECTION I: BACKGROUND

 

1.0 Introduction

challenges facing small island developing states. Since 1994, successive conferences and resolutions haveNations General Assembly established the Barbados Program of Action (BPOA) to address systemic  he year 2014 marks the International Year of Small Island Developing States, and a decade since the United

elaborated those challenges in the terms of the global sustainable development agenda.

In 2012, the Barbados Declaration on Achieving Sustainable Energy for All in Small Island Developing States reaffirmed that

“… SIDS continue to face acute sustainable development challenges resulting from their unique and specific vulnerabilities and characteristics. SIDS remain highly vulnerable notably due to their small open economies, narrow resource base, disadvantages in economies of scale, remoteness, high export concentration, high dependency on imports with high vulnerability to energy and food price shocks and speculation, and relatively high levels of national debt. These combined vulnerabilities have been further exacerbated by the current global energy, food, financial and economic crises, the increased incidence of natural disasters, and environmental challenges.”  

Many of those challenges persist today. Nevertheless, the consensus within the development community has long since targeted renewable energy as an investment category capable of delivering benefits to begin to address many of these interlinked challenges. These benefits will additionally help to modernize the energy sectors of these developing economies. Despite this consensus, renewable energy deployment remains low.

Section I of this paper situates the state of energy modernization of small island economies within two interlined contexts: climate change and the comparative macroeconomic efficiency of energy sector compositions. This section examines the paradox that SIDS aren’t the primary culprits of climate-related environmental change due to anthropogenic emissions from energy use, yet their fossil fuel imports impede climate protection through economic effects. Meanwhile, current and future, slow, and sudden-onset climate hazards threaten islands’ security along several dimensions. It then examines how renewable energy can address many of the interlinked challenges that structurally weaken SIDS today.

Section II of this paper develops a novel theoretical and empirical framework for estimating the macroeconomic impact of renewable energy investments in small island economies. With it, this paper verifies expected gaps between the efficiency of renewable energy investments to improve macroeconomic performance over fossil fuel imports. This research therefore underscores the viability of renewable energy investments in SIDS to act as a lever to improve economic output, as well as local environmental protection. As such, this study also implies the viability of dual purpose climate change mitigation and adaptation programming as modes of sustainable development in SIDS.

 

1.1 SIDS and Climate Change

The consensus that global climate change portends grave impacts on islands is widely accepted. Global manmade emissions from fossil energy use and land use change augment natural processes contributing to drivers of risk such as sea-level rise, cyclones, increasing air and surface temperatures, and changing rainfall patterns. These hazards – which have direct economic impacts such as storms that can undo an entire year’s worth of economic output – threaten to undermine key economic sectors in SIDS including tourism, fisheries, and agriculture.

Meanwhile, markets are failing to provide the level of incentives needed for climate stabilization through shifts to sustainable energy. International climate action has largely reflected that inertia.

Due to SIDS’ small size and insularity, climate change adaptation – which entails large infrastructural outlays – is vital to economic stability, but has high per-capita overhead costs. Island economies and their partners must therefore marshal significant resources (financial, technological, and human) as efficiently as possible. Section 1.2 examines the state of energy in SIDS today. In combination with Section 1.3, it extends the frequently cited argument that savings on fossil fuels through renewable energy build-outs at-scale, with demand, can empower islands to execute sustainable development activities, including adapting to a changing climate.

 

1.2 Reducing Foreign Oil Dependence in SIDS

SIDS spent at least US$ 137 billion on fossil fuel imports in 2012 alone. Since 2000, fuel demand in dollars has increased by approximately 700%.

Sids Impact

Figure 3: Based on calculations of all available data for SIDS: “fuel imports, % of  merchandise imports” and “merchandise imports, US$.” Source: Raw data from World Bank Data Bank World Development Indicators.

Given their narrow resource bases, most SIDS are almost entirely reliant upon foreign supplies to meet electricity and transport sector energy demand. Reducing SIDS’ dependence on imported fuels therefore represent high-impact opportunities for sustainable development. Beginning with foreign currency savings, decreasing SIDS’ reliance on imported fuels (of which oil products are largest category) is likely to positively affect macroeconomic stability, independence, and growth prospects.

The sensitivity of island economies to shocks in oil prices is well-documented (Niles & Lloyd). SIDS’ exposure to oil prices is particularly ominous at a time when oil prices are expected to rise. Base-case projections from the United States’ Energy Information Administration estimate that by 2040, each barrel of oil will cost $141, a more than 25% increase on the 2012 price of $112. Atop market effects – like growing demand in Asia or the growing expense of producing supplies through more expensive, unconventional means like hydraulic fracturing or tar sands extraction – islands face inherent price challenges due to their sizes of their economies and remoteness from large suppliers. Rising prices are further compounded by the sensitivity of the shipping industry to fuel prices.

SIDS commonly spend the equivalent of more than 50% of their foreign currency reserves on petroleum and other fuel imports in a given year, a percentage that fluctuates with the volatility of global oil and commodities markets.

SIDs Fuel Import

Figure 4: Source:  Calculations based on all available data for SIDS in World Bank Data Bank World Development Indicators.

Fuel imports also exacerbate current accounts deficits in many SIDS. Beginning in 2004, they surpassed the total value of all exports in the region. By 2012, fuel imports in the Caribbean were worth 550% of the total value of regional exports. There is little doubt that fossil fuel import dependence is contributing to debt in SIDS, particularly in the Caribbean region.

Under the most generous schemes in the world (such as PetroCaribe), Caribbean SIDS hold outstanding loans to oil exporters that approach or surpass 10% of their GDP (IMF 2014). The International Monetary Fund’s (IMF) 2014 Spillover Report detailed the risks of dependence of some Caribbean SIDS to such generous loan terms. If those agreements degrade (for instance, if Venezuela faces binding external liquidity constraints), some SIDS with difficult balance of payments scenarios and low access to international markets may be forced to approach the IMF for concessional loans.

As such, fuel imports to island economies contribute to energy insecurity by exposing SIDS to high and variable year-to-year energy costs, or through dependence on potentially unsustainable loan agreements. The lack of affordable or predictable energy costs impedes policy-planning processes and can threaten islands’ solvency. As an iterated challenge, only the displacement of fuel imports through renewable energy investments portend a sustainable solution. Additionally, SIDS with less-than-complete access to electricity have opportunities to leapfrog fuel import dependence and the related sets of macroeconomic hazards.

 

1.3 The Case for Renewable Energy in SIDS

There are three primary courses of action to effectively reduce foreign oil dependence in SIDS.

  1. Decreasing demand for transportation fuels
  2. Increasing energy efficiency
  3. Building renewable energy capacity to scale

The vast majority of fossil fuels imported to these regions is petroleum; categories of natural gas and coal make up the remainder of imports (see Appendices A5, A6). The largest fraction of petroleum imported to SIDS is used for transportation. Changes in the transportation sector such as improving vehicle fuel economy and emissions standards, or investing in public transportation are ways to decrease the demand for transportation fuels. The second largest share of petroleum imports are used for energy production. Increasing energy efficiency is an inexpensive way to reduce energy demand relative to generation capacity, however, only locally-sourced energy could correct the inefficiency of importing commodities with high and variable prices.

Diversifying the energy sectors of SIDS would not only lead to reduced dependence on foreign oil and fuels, and increased availability of foreign currency reserves, but it is also predicted to result in benefits associated with infrastructure, environment, health, and other sectors. These benefits also include improved electricity access and reliability and increased regional collaboration through energy trading.

Many SIDS have small economies and low levels of exports. These and other economic conditions make it difficult for them to support major infrastructure. However, there is increasing global attention being drawn to the issue of climate change, which is inspiring foreign investment from governments, private companies and multinational organizations.

Despite their geographic isolation typically serving as a disadvantage for SIDS, their location often provides immense potential for renewable energy production. Antigua and Barbuda, The Bahamas, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines are all projected to have 10-100MW potential capacity for solar power generation as well as significant energy production from at least one other renewable energy source such as wind and geothermal, as well as untapped ocean mechanical and thermal energy resource potentials. The International Renewable Energy Agency (IRENA) has made similar predictions for states in the Atlantic, Indian Ocean and South China Sea region (AIMS) and Pacific Ocean Region in their Renewable Energy Country Profiles.

Nevertheless, the deployment of renewable energy in small island economies remains low. Values for renewable energy generation ranged from 0% in over a dozen island economies to 74% in Belize. Renewable energy generated on average, only 13% of electricity in a given island economy. Despite this, renewable energy generation targets are strengthening. This may reflect policymakers’ growing confidence in the feasibility or viability of new renewable energy deployments.

Although there is much potential for renewable energy development in SIDS, they face a myriad of interlocking sets of challenges in bringing these projects to fruition.

  1. Overcoming political and regulatory challenges
  2. Securing sustainable energy investment
  3. Developing the technological capacity for operation and maintenance

The International Renewable Energy Agency’s (IRENA) August 2014 report, Renewable Islands: Settings for Success, argued that combinations of political prioritization, open markets, technical planning, and capacity building have catalyzed renewable energy investment inflows in Cabo Verde, Cyprus, Fiji, and Samoa – and suggests a model that SIDS can use to proactively reorder public policy to attract sustainable energy investment partnerships.

The report also emphasized that renewable energy projects were undertaken in part to curtail high retail electricity rates. Fuel imports in 2012 ranged from the equivalent of US$ 600 to US$ 3500 for person living in small island economies. As the upper range of retail electricity prices in SIDS exceeds 40 U.S. cents per kilowatt-hour, and as many renewable energy technologies become increasingly affordable (see Appendices A7-A9), renewable energy deployment will become an increasingly attractive option for replacing energy infrastructures in SIDS.

While tangible difficulties that impede renewable energy deployment in SIDS – front-end investment expenses, though shrinking, are chief among them – the fiscal challenges SIDS face in procuring fossil fuels are iterated indefinitely. In comparison, the challenges related to attracting investment for sustainable energy projects are each one-off challenges.

 

SECTION II: THE STUDY

2.1 Research Objective

The objective of this study is to analyze the macroeconomic benefits of renewable energy investment in SIDS, particularly by looking at its effects on GDP. This analysis will be used as evidence of the direct macroeconomic benefits of clean energy in order to incentivize SIDS’ leaders and their international partners to invest in clean energy development. Two of the biggest financial limitations of SIDS renewable energy investments is their ability to finance projects and the long pay-off time for renewable energy projects compared to fossil fuel projects. The results of this study will hopefully be a tool used to mitigate both of these issues by providing evidence for the macroeconomic benefits of renewable energy investment.

 

2.2 Data

Panel renewable energy data and macroeconomic data were collected for 16 SIDS from 2002-2013.

Renewable Energy Investment Data

Renewable energy investment data is based on the Bloomberg New Energy Finance Database. It contained 45 renewable energy projects from 2002 to 2013 in 17 SIDS. The data was then filtered in the following ways:

First, only projects whose statuses were “under construction” or “complete” were counted as relevant samples. “Planned” and “announced” projects do not guarantee final project execution, and more importantly, “planned” and “announced” projects do not create real economic output.

Second, although most projects indicated the financing amount, missing values for some projects would have prevented the most accurate analysis possible due to a low sample size. In order to use the maximum amount of observations for renewable energy investment, the multiple imputation method was applied (Allison, 2000) in order to estimate investment values for 8 projects. Although the introduction of this method may bring along the data bias and in turn decrease the statistical accuracy, it is necessary to apply it in order to get a cleaned and balanced data set.

Macroeconomic Data

Macroeconomic data was collected from World Bank DataBank’s World Development Indicators database. The macroeconomic indicators of concern include GDP in current US dollars, total population, international tourism receipts in current US dollars, gross capital formation in current US dollars, and fuel imports in current US dollars.

Dependent and Independent Variables

Gross Domestic Product:  GDP in current dollars was chosen as the macroeconomic indicator of interest and dependent variable. Despite its limitations, it continues to represent the broadest measure of macroeconomic performance.

The independent variables chosen are as follows.

  • Population: In order to retain population as a potential explanatory variable, GDP was preferred over GDP per capita; therefore panel data was collected on GDP in current US dollars.
  • Tourism receipts: tourism represents a primary industry for many SIDS.
  • Gross capital formation is essentially the total investment in an economy in a given period.
  • Fuel imports were selected in order to compare the effect of renewable energy inputs with energy from fossil fuel inputs. A direct comparison of renewable energy investments versus fossil fuel investments was impractical and could potentially have been misleading.

Data on existing fossil fuel-based energy infrastructures proved too difficult to collect with much confidence. Additionally, fossil fuel-based energy has developed in SIDS for over a century. Marginal return and marginal cost change due to economies of scale, and historical large-scale investments in fossil fuel-based energy sectors in the past produce relatively large amounts of energy with little new investment. Finally, because most island countries have little or no petroleum, gas, or coal reserves, the majority of inputs are from fossil fuel imports. Therefore, as a compromise, fuel imports in current US dollars were chosen as the final independent variable rather than investments in the “old” energy sector to in order to draw accurate comparisons with renewable energy investments, which are the primary inputs for producing renewable energy.

Once the variables were finalized, the natural logarithm of each variable was taken. This was useful for three reasons. First, if variables grow at a constant rate, the log form will grow as linear function. Second, variables with nonlinear relationships in economics appear linear in log form. Last, estimated coefficients in log regressions aid the final interpretation of results.

Countries

Macroeconomic data was present for the same 16 countries that had renewable energy projects during the same period (2002-2013). Singapore posed a substantive concern, however, as a much larger economy than other SIDS. Nevertheless, because of Singapore’s classification as a small island developing state, and because this study required a critical mass of observations for renewable energy investments, Singapore was retained in the sample.

After using the multiple imputation method and cleaning observations without sufficient macroeconomic data, the total number of observations was finalized at 38 investments. The following table is the summary of the investment values for all countries.

Renewable Energy Investment Value

Table 1: Renewable Energy Investment value by Country and Region

Renewable Energy Technologies

Investments included solar, wind, geothermal, biofuels, biomass and waste, and small-scale hydroelectric projects. Because base-load technology categories like geothermal, ocean    kinetic, and ocean thermal represented low or non-existent portions of the dataset, our model could ultimately underestimate the potential macroeconomic benefits from renewable energy investments.

Figure 2

Figure 5: Technology breakdown of renewable energy investments in the  sample set as a percentage of number for which there was sufficient  total RE investment amount for 16 SIDS (the 2013 data to include in the study). Source: Calculations based on data from Bloomberg New Energy Finance Database.

 

2.3 Research Method

This study was done with the following assumptions.

  • Renewable energy investments may directly affect the overall composition of a nation’s capital stock. Thus, renewable energy investments may also affect both the short and long run growth rate of an economy.
  • Tourism is a factor that may significantly affect macroeconomic activities in small developing islands.
  • Small developing islands heavily rely on imported fossil fuel imports. Fuel imports negatively impacts the current account, it may also have a negative effect on GDP overall.

Khaliq and Noy (2007) analyze the effect of foreign direct investment on economic growth using a panel data approach with fixed effects. Following a similar empirical approach to model the effect of renewable energy investments on GDP, the empirical model can be expressed in the following manner.

ln 𝑌𝑐,𝑡 = 𝛼0 + 𝛼[1]ln𝐾𝑐,𝑡 + 𝛼2lnP𝑐,𝑡 + 𝛼3lnRe𝑐,𝑡 + 𝛼4lnFm𝑐,𝑡 + 𝛼5lnTou𝑐,𝑡 + δ𝑐 + 𝜀𝑐,𝑡     (1)1

Where,

𝑐, 𝑡, denotes country and time subscripts,

𝛼0, denotes a constant which capture the change in total factor productivity ln 𝑌𝑐,𝑡, denotes the log of GDP

ln𝑃𝑐,𝑡, denotes the log of total population lnK𝑐,𝑡, denotes the log of gross capital formation  lnRe𝑐,𝑡, denotes the log of renewable energy investments lnTou𝑐,𝑡, denotes the log of tourism lnFm𝑐,𝑡, denotes the log of fuel imports δ, denotes country fixed effects, used to capture the heterogeneity across countries.  𝜀𝑐,𝑡, denotes the error term

The expected empirical results are expected to follow previous theoretical assumptions made

𝛼1 > 0; 𝛼2 > 0; 𝛼2 > 0; 𝛼2; 𝛼3 > 0; 𝛼4 < 0; 𝛼5 > 0     (2)

Equation (1) represents the base empirical model needed to estimate the effect of renewable energy investments on macroeconomic performance.

 

2.4 Econometric Results

The empirical results of the estimations will be shown in this section. As expected, renewable energy is making a significant contribution to the regional macro-economic growth. No statistically significant macroeconomic impact has been discovered in terms of fossil fuel imports, which has been the major source of energy for small island developing states (SIDS) for decades.

Several econometric techniques were adopted to compare the results. The baseline model was the robust Ordinary Least Square (OLS) model with solely key variable, the total value of renewable energy investment, included (see Table 2, column 1). Table 2, column 2 shows the result generated by incorporating our full set of control variables (fuel imports, international tourism, population, and gross capital formation, which were carefully chosen based on the macro economic theory). Then the hypothesis was tested using fixed effects (FE) regression models (see Table 2, column 3 and 4) to increase the statistical accuracy of the examination. Two FE specifications were run: one using all variables and the other only including statistically significant variables. Country-fixed effects are included in the FE regressions with the purpose of controlling unobserved heterogeneity.

Table 2

Table 2: Regression results. Notes: Robust standard errors are in parentheses. * indicates significant at 10%; ** indicates significant at 5%; and *** indicates significant at 1%. Source: Calculations based on data from Bloomberg New Energy Finance Database and World Bank DataBank World Development Indicators, 2000-2013. 

As the baseline model (Table 2, column 1) shows, renewable energy has a significant impact on the macroeconomic performance at the country level. The coefficient of the key independent variable is statistically significant at the 1% level. The coefficient is positive on total value of renewable energy investment (0.0006461) with a poor model fit, however, at 0.141. The finding of OLS regression with control variables can be found in column 2 of the above table. The model fit is considerably improved from 0.141 to 0.976. However, a surprisingly negative sign of renewable energy investments is discovered, but without any statistical support shown. The other insignificant variable presented is the fuel imports in this OLS specification, which indicates that fossil fuel consumption does not necessarily make contributions to a nation’s economic growth. Our conjecture of this seemingly illogical finding is that fossil fuel consumption is not a major component of a nation’s GDP at the macro level. Theoretically, consumption, investment, government spending, and net export are the four critical determinants of GDP. Based on our data collection and calculation, the ratio of fossil fuel import to GDP varies from 0.39% to 54.47%, with an average at 15.16%. Therefore, it is reasonable to obtain a statistically insignificant coefficient of fossil fuel.

Results from more sophisticated regression models, Fixed Effects models, have confirmed the hypothesis that promotion of renewable energy projects in the SIDS region has macroeconomic benefits to these economies. Renewable energy investments have significantly positive effects on GDP, the most commonly used macroeconomic indicator. Specifically, the coefficient discovered in FE model with all variables included is 0.0419 (see column 3), which is statistically significant at a 10% level. This finding indicates that for 1 percent increase in renewable energy investment, the GDP of SIDS countries can be expected to increase by approximately 0.0419 percent. A notable finding is that the variable of fuel imports remains its statistical insignificance, while capital and population significantly affect GDP.

The statistical significance of the variable of interest (total value of renewable energy investment) is greatly improved from a 10% level to a 1% level, excluding non-significant control variables. Table 2, column 4 shows that a slightly bigger macro-economic impact (0.0492, instead of 0.0419) can been expected from renewable energy investments. A bigger R2 (0.804, compared with 0.797 seen in column 3) also indicates a better model fit. Approximately 80% of the variation in the sample can be explained by regression 4 (Table 2, column 4).

Impact on GDP

Figure 6: Results. Renewable energy investment in SIDS contributed to GDP.

 

2.5 Limitations

Multicollinearity among explanatory variables may be a source of bias. Moderate to high correlations (from 0.78 to 0.91) are discovered between capital and other variables, such as fuel imports, population, and tourism . Therefore, a multicollinearity problem may exist when including a full set of control variables. Technically speaking, the inconsistent OLS finding with controls (Table 2, column 2) might also be a result of this multicollinearity problem. In addition, results show higher statistical significance when dropping some of the highly correlated variables.

Other minor econometric issues that our analysis may have include measurement bias and omitted variable bias. A relatively small sample size as a result of data limitations (the number of observation for each variable is 38) may bring up some statistical inaccuracy as well.

Although future econometric improvement on this topic can be made by enlarging sample size and including other control variables, this analysis provides valuable insight on investigating the macroeconomic impacts of renewable energy projects in the context of small island developing states. Policy makers can better design the policy in promoting renewable energy at a large scale based on the findings of this empirical research.

Finally, it must be noted that the sample size of island countries and the number of control variables used had to be restricted based on limits of available and of consistent data reporting. A major effort should be made by SIDS and their international partners to improve this situation for the future, especially regarding indicators of world development.

 

2.6 Conclusion

As sea levels rise and weather patterns change, many states are being forced to adapt in order to ensure their survival. Additionally, SIDS heavy reliance on imported fossil fuels for energy production is becoming increasingly unsustainable with rising oil prices, driving SIDS to explore options to diversify their energy sectors.

Renewable energy is a viable, though vastly under-utilized, option for SIDS to increase both foreign currency reserves available for investment and to diversify their energy sectors.  Renewable energy’s potential to reduce the demand of imported fuel liberates foreign currency reserves to be used for investment in climate adaptation projects such as the construction of seawalls and improvement of roads. Diversifying the energy sectors of SIDS using renewable energy investment would lead to reduced international dependence by mitigating participation in programs such as the PetroCaribe between Venezuela and the Caribbean, and other similar arrangements. It would also likely result in an increased electrification of SIDS.

Renewable energy investment in SIDS is not without its challenges. At the 2005 UN Conference on Small Islands in Mauritius, the majority of states cited project financing as the largest hurdle in pursuing renewable energy projects. Other challenges include energy policy and markets that do not allow for independent energy production. Evidence of the benefits of renewable energy investment, however, can be used to attract external investors and to incentivize policy changes that facilitate renewable energy production. The macroeconomic study described in this paper shows that the benefits of renewable energy investment include a positive correlation between renewable energy investment and GDP; a benefit that would benefit both foreign investors and SIDS.

Despite the challenges SIDS face, they are taking steps towards bringing renewable energy projects to fruition. At present, the majority of SIDS already have renewable energy targets set for the next several decades. For example, REN 21’s Renewable Global Status Report has reported Barbados as having a goal of 29% electricity generation from renewables by 2029 and Vanuatu as having a goal of 65% by 2020. Some states have even begun to incorporate renewable energy sources into their energy make up. As of 2012 the Dominican Republic produced 14% and Fiji produced 67% of its energy from renewables. At present, Sustainable Energy for All, a global energy initiative has an established a goal  for all countries to double their current renewable energy production, ensure access to modern energy services, and improve the rate of energy efficiency by 2030. SIDS’ investments in renewable energy would put them on the path towards accomplishing these goals. Additionally, there has been increased focus on investment and development in SIDS with 2014 as the International Year of Small Island Developing States, marking a decade since the UN General Assembly established the Barbados Program Plan of Action. In this, the inaugural year of Decade of Sustainable Energy for all, the empowerment of SIDS to both improve macroeconomic performance and to protect themselves from a changing climate – and indeed, both goals reinforce one another – cannot be delayed another decade. The newest elaboration of challenges and efforts to bridge the divide between the status quo and a sustainable energy future – the “SIDS Accelerated Modalities of Action (S.A.M.O.A.) Pathway” – must therefore represent a jumping-off point from which stakeholders seize upon opportunities to create value in small island developing states.

Note that other variables such as gross capital formation and population were added to the equation to satisfy the literature on economic growth. These factors are also instrumental to macroeconomic performance.

 

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