# Energy, the economy and the future: Energy and the economy

Source page: https://www.materialinsights.org/learn/energy/energy-economy-society/p1/

[Understanding Energy](https://www.materialinsights.org/learn/energy/) / [Module 14: Energy, the economy and the future](https://www.materialinsights.org/learn/energy/energy-economy-society/) Part 1 of 4

## Energy and the economy

Economic statistics measure money, but every product and service is also a flow of energy and materials. Seeing the economy this way explains why rich countries use so much more energy than poor ones, why that link loosens at high incomes, and why market prices tell only part of the story about what energy really costs.

### 1.1 Every economic activity is an energy conversion

Mainstream growth theory explains output with labour, capital and technology, and treats energy as one input among many, worth only what is spent on it. In rich economies spending on energy is usually a small share of GDP, often well under a tenth, so by that logic energy looks marginal. Smil argues that this badly understates its role. Without a steady supply of fuels and electricity, labour and capital produce almost nothing: no farm machinery, no fertiliser, no steel, no freight, no data centres. Energy is less like one ingredient in a recipe and more like the heat that cooks the whole meal.

Across countries, the link between energy and income is strong. Plot energy use per person against GDP per person for the world's nations and the two rise together; Smil's Global Ecology reported a worldwide correlation above 90%. At the extremes the gap is stark: the poorest countries use a few tens of GJ of commercial energy per person a year at most, the richest well over a hundred.

Among countries at similar incomes, however, the link is loose. Japan and the large European economies use roughly half as much energy per person as the United States or Canada, at broadly comparable living standards. Climate, the size of the country, how densely people live, the weight of heavy industry, fuel prices and plain habit all matter.

Smil's long historical view adds a caution. Energy sets the limits of what a society can do, but it does not decide what that society does within those limits. Institutions, ideas, trade and politics shape whether abundant energy produces broad prosperity or waste. In Grand Transitions he links five great changes, in population, food, energy, economies and the environment, and shows that each depended on the others. None of the economic transformations of the past two centuries could have happened without fossil fuels, but fossil fuels alone did not make them happen.

Process flowchart From crude oil to a freight service Inputs **Crude oil**1 t, about 42 GJ Process steps 1 **Refinery**

about 90% of the energy ends up in products such as diesel
 2 **Diesel truck engine**

about 35 to 40% of fuel energy becomes motion
 3 **Road haulage**

a heavy truck uses roughly 1 MJ of fuel per tonne-kilometre
 Outputs **Freight moved**very roughly 35,000 tonne-km **Heat losses**most of the original 42 GJ

GDP records the haulage bill; the energy chain shows what made the service physically possible. Values are indicative.
 Source: Smil, Energy in Nature and Society: General Energetics of Complex Systems (2008), via Smil Mastery Course, M13 'Energy and economic growth'  Common misreading

#### GDP is not the same as welfare

GDP adds up market transactions. It counts the cost of cleaning up an oil spill or treating asthma caused by air pollution as output, and it ignores unpaid work and the depletion of natural resources. Smil cites the Index of Sustainable Economic Welfare built by Herman Daly and John Cobb, which adjusts for such factors: US national product roughly doubled between the early 1960s and the mid-1980s, while the welfare index barely moved. Energy statistics and money statistics both need careful reading before they are taken as measures of well-being.

- Smil, Energy at the Crossroads: Global Perspectives and Uncertainties (2003) · via Smil Mastery Course, M13 'Energy and economic growth'
- Smil, Global Ecology: Environmental Change and Social Flexibility (1993) · via Smil Mastery Course, M13 'Energy and economic growth'
- Smil, Grand Transitions: How the Modern World Was Made (2021) · via Smil Mastery Course, M13 'Energy and economic growth'
- Smil, Energy and Civilization: A History (2017) · via Smil Mastery Course, M13 'Energy and economic growth'

### 1.2 Energy intensity falls as economies mature, but comparisons need care

Energy intensity is primary energy used per unit of GDP, for example megajoules per dollar. A falling intensity means an economy is producing more output from each unit of energy.

The typical path has a hump. In early industrialisation intensity rises, because a country is building railways, steel mills, cement plants, power stations and cities, all of which use a lot of energy per dollar of output. Later it falls, as the economy shifts towards services, machines become more efficient and the basic infrastructure is finished. China is a remarkable case. Smil showed that its energy intensity began to fall even before the economic reforms of 1979 and then dropped steeply through the 1980s and 1990s, unusually early for a country still industrialising so fast.

Before comparing countries, Smil insists on taking the number apart. Converting GDP at market exchange rates makes poor countries look extremely energy-intensive; converting at purchasing-power parity, which reflects local prices, shrinks that apparent gap considerably. Whether traditional biomass is counted changes the energy figure for countries such as India or Nigeria. Cold climates need more heating and large countries more transport. An economy built on aluminium smelting or oil refining will look intensive even if each of its plants is efficient.

Two traps follow. First, falling intensity is not falling use. World energy intensity has declined for decades while total energy use kept rising, because GDP grew faster still. Second, rich countries flatter their figures by importing steel, cement, chemicals and manufactured goods. The energy used to make them, and the emissions, are counted where the factories are, often in China or India.

Intensity remains a useful policy target. At the COP28 climate conference in 2023, governments agreed to aim to double the global rate of energy intensity improvement to about 4% a year by 2030. The IEA's Energy Efficiency 2025 report shows progress well short of that: about 1% in 2024 and, on preliminary estimates, 1.8% in 2025.

Data What moves a country's energy intensity

| Factor | Pushes intensity up | Pushes intensity down |
|---|---|---|
| Stage of development | building infrastructure and heavy industry | mature, service-based economy |
| Economic structure | steel, cement, aluminium, refining, chemicals | finance, software, tourism |
| Climate and geography | cold winters, long distances | mild climate, dense cities |
| GDP conversion | market exchange rates for poorer countries | purchasing-power parity |
| Trade | exporting energy-intensive goods | importing them |
| Accounting | counting traditional biomass | leaving it out |
| Technology | old, inefficient plants | efficient motors, LEDs, heat pumps |

 Source: Smil, Energy at the Crossroads: Global Perspectives and Uncertainties (2003), via Smil Mastery Course, M13 'Energy intensity'  Case

#### China: falling intensity, soaring use

Smil's work on China shows both sides of the intensity story. From the late 1970s, closing wasteful small plants, modernising industry and reforming prices let China's GDP grow far faster than its energy use, so energy intensity fell steeply for two decades. Yet total energy use still multiplied, and coal output eventually rose to around 4 billion tonnes a year, making China the world's largest energy consumer and CO2 emitter. Efficiency gains made each unit of growth cleaner, but growth itself was so fast that absolute demand kept climbing.

- Smil, Energy at the Crossroads: Global Perspectives and Uncertainties (2003) · via Smil Mastery Course, M13 'Energy intensity'
- Smil, China's Past, China's Future: Energy, Food, Environment (2004) · via Smil Mastery Course, M13 'Energy intensity'
- Smil, Global Ecology: Environmental Change and Social Flexibility (1993) · via Smil Mastery Course, M13 'Energy intensity'
- IEA, Energy Efficiency 2025 (2025) · improvement of 1% in 2024 and 1.8% (preliminary) in 2025, against the COP28 doubling goal, https://www.iea.org/reports/energy-efficiency-2025

### 1.3 Energy prices fell for a century, but real costs include what prices leave out

For most of the twentieth century the real, inflation-adjusted prices of the main energy services fell. Electricity became cheaper, and much cheaper still relative to wages. Light became astonishingly cheap compared with candles or kerosene lamps. Oil, despite the shocks of the 1970s, was cheap for most of the century. Falling prices drove consumption, and cheap energy is one of the hidden foundations of modern productivity.

Market prices, however, leave out many costs. Burning coal and oil causes air pollution that shortens millions of lives a year; acid deposition damaged lakes and forests; CO2 changes the climate; oil spills foul coasts; and some countries spend heavily on military power to keep oil flowing. Economists call these external costs. Smil reviews many attempts to put a money value on them and stresses their wide uncertainty: estimates can differ tenfold or more depending on assumptions about health effects, discount rates and future damage. Uncertainty is not a reason to treat them as zero, which is exactly what an unadjusted market price does.

Subsidies distort prices further. Many governments, India's among them in the past, have held fuel and electricity prices below cost for consumers, and others subsidise producers. New renewables have also received large support through feed-in tariffs, tax credits and guaranteed contracts. Comparing technologies on subsidised prices can mislead in either direction.

The newest price story is the collapse in the cost of clean technologies. The IEA estimates that since 2010 the cost of solar power has fallen by about 90%, wind by about 70% and batteries by about 90%. In many markets, including India, new solar is now the cheapest source of bulk electricity. But the cost of a kWh at the plant gate is not the cost of a reliable supply at the moment it is needed. Integration costs, for storage, grids and backup, rise as variable sources grow, and they are where the next arguments about price will be fought.

Data Costs inside and outside the price of energy

| Cost | Usually in the market price? | Example |
|---|---|---|
| Fuel, plant and labour | yes | coal delivered to a power station |
| Air pollution and health | rarely | fine particles from coal and diesel |
| Climate damage from CO2 | only where carbon is priced | emissions trading in the EU; India's planned carbon market |
| Local environmental damage | partly | mine land, oil spills, acid deposition |
| Security and military costs | no | naval protection of tanker routes |
| Subsidies | they lower the price | below-cost fuel or power tariffs |
| Grid integration of variable power | often not in plant-gate cost | storage, transmission, backup capacity |

 Source: Smil, Energy at the Crossroads: Global Perspectives and Uncertainties (2003), via Smil Mastery Course, M13 'Prices, real costs and energy in war'  In the data

#### Learning curves explain the solar collapse

Manufactured technologies tend to get cheaper by a roughly constant percentage each time cumulative production doubles. For solar modules that learning rate has historically been around 20% or more per doubling. Because global solar output has doubled many times since 2010, the compounding effect is the roughly 90% cost fall the IEA reports. Fuels do not behave this way: the cost of coal, oil or gas depends on geology, depletion and politics, and can rise as easily as fall. That difference is the strongest economic argument for expecting clean technologies to keep gaining ground.

- Smil, Energy at the Crossroads: Global Perspectives and Uncertainties (2003) · via Smil Mastery Course, M13 'Prices, real costs and energy in war'
- Smil, Energy in Nature and Society: General Energetics of Complex Systems (2008) · via Smil Mastery Course, M13 'Prices, real costs and energy in war'
- Carbon Brief, 'IEA: Fossil-fuel use will peak before 2030 unless stated policies are abandoned' (November 2025) · summary of IEA World Energy Outlook 2025 scenario results, https://www.carbonbrief.org/iea-fossil-fuel-use-will-peak-before-2030-unless-stated-policies-are-abandoned/
- IEA, World Energy Outlook 2025 (2025) · Overview and key findings, https://www.iea.org/reports/world-energy-outlook-2025/overview-and-key-findings

### See it in the table
[Al Aluminium](https://www.materialinsights.org/commodities/aluminum/)[St Steel](https://www.materialinsights.org/commodities/steel/)[Cem Cement](https://www.materialinsights.org/commodities/cement/)[DC Data centres](https://www.materialinsights.org/energy/e_data_centres/)

### Check your understanding

Why does energy look unimportant in standard growth accounting?
 Measuring an input by its cost share understates something that every other input depends on.

A poor country's energy intensity looks very high when GDP is converted at market exchange rates. What usually happens if purchasing-power parity is used instead?
 PPP reflects lower local prices, so GDP in PPP terms is larger, and energy per unit of GDP is smaller.

According to the IEA, roughly how much did the cost of solar power fall between 2010 and 2025?
 The IEA puts the decline at about 90% for solar and batteries and about 70% for wind.

[← Module contents](https://www.materialinsights.org/learn/energy/energy-economy-society/)[Mark read · Part 2: Energy and human welfare →](https://www.materialinsights.org/learn/energy/energy-economy-society/p2/)

## Other sections

- [Module overview](https://www.materialinsights.org/learn/energy/energy-economy-society/index.md)
- [Energy and human welfare](https://www.materialinsights.org/learn/energy/energy-economy-society/p2/index.md)
- [Energy, war and security](https://www.materialinsights.org/learn/energy/energy-economy-society/p3/index.md)
- [Growth, forecasts and the future](https://www.materialinsights.org/learn/energy/energy-economy-society/p4/index.md)
- [Key terms, quiz and sources](https://www.materialinsights.org/learn/energy/energy-economy-society/review/index.md)