Rising energy prices in the U.S. reduce the economic output of states, but they also set in motion investments in more efficient equipment and technologies that partially offset those output losses over time, according to a new study by researchers at Penn State.
"At a time when rising energy prices are a top concern for policymakers, businesses and households, our study highlights the dual nature of energy price shocks," said Minsu Kim, a postdoctoral researcher at the Northeast Regional Center for Rural Development (NERCRD) in Penn State's College of Agricultural Sciences, who led the study. "While such shocks impose real economic costs in the short run, they also spur technological and structural changes that improve productivity and reduce energy dependence, helping economies become more resilient over the long term."
The study, published in Energy Economics, draws on the economic theory of induced innovation, which holds that when the price of an input rises, firms focus investments to use less of that input. In this case, the idea is that as energy prices increase, companies innovate solutions to compensate for the extra cost - either by developing alternate processes or new technologies. To test this theory and understand how states respond to short- and long-term energy price increases, the researchers used annual data from 2001 to 2019 for all 50 U.S. states and Washington, D.C., and developed a dynamic statistical model that tracks how energy prices affect output, investment, capital accumulation and energy intensity - the amount of energy required to produce a dollar of economic output.
The researchers found that a 1% increase in energy prices reduced states' gross domestic product (GDP) by 0.11% to 0.18% in the short run, as higher costs rippled through nearly every sector of production. On the other hand, the analysis also suggested that the same energy price increases stimulate investment in newer, more energy-efficient machinery. The team found the strongest responses in manufacturing-intensive states, such as Indiana, Michigan and Wisconsin, where energy demand was most sensitive to prices. However, Kim said, evidence of this offset from energy efficiency improvements on short term economic decline appeared across the nation. Over time, these investments lowered energy intensity, allowing businesses to produce more output with less energy.
The resulting efficiency gains offset roughly 2% to 5% of the initial economic losses, but these gains do not arrive immediately. The study estimated that the adjustment unfolds over roughly 14 years, a timeline that matches the replacement cycle of major industrial capital, such as machines, equipment or buildings.
These adjustments are made voluntarily, which suggests the timing of policy is critical, said Stephan Goetz, professor of agricultural economics and regional economics at Penn State, director of the NERCRD and a co-author of the study.
"Because firms are already motivated to invest in efficiencies when energy prices are high, policy makers can amplify the long-term returns on such investment through policy levers - such as investment tax credits, accelerated depreciation, low-interest financing for efficient equipment and industrial retrofitting programs," Goetz said. "Well-designed energy and economic development policies can help communities cope with energy price shocks in the short-term and better prepare for future shocks."
The NERCRD at Penn State is one of the nation's four Regional Rural Development Centers that work in partnership with the land-grant university system to address crucial needs in the United States' rural communities. The NERCRD serves the 12-state region from Maine to West Virginia and Washington, D.C.
This work was supported in part by the United States Department of Agriculture's (USDA) National Institute of Food and Agriculture, under projects #2024-67023-42614 and #2024-51150-43729; Penn State and Hatch Multistate Appropriations under project #PEN04802 and accession #7003365.
