energy consumption and economic growth nexus in tanzania- an ardl bounds testing approach.pdf
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Energy consumption and economic growth nexus in Tanzania: An ARDL
bounds testing approach
Nicholas M. Odhiambo
Economics Department, University of South Africa (UNISA), P.O. Box 392, UNISA, 0003, Pretoria, South Africa
a r t i c l e i n f o
Article history:
Received 29 August 2008
Accepted 15 September 2008Available online 21 November 2008
Keywords:
Tanzania
Energy consumption
Economic growth
a b s t r a c t
In this paper, we examine the intertemporal causal relationship between energy consumption and
economic growth in Tanzania during the period of 19712006. Unlike the majority of the previous
studies, we employ the newly developed autoregressive distributed lag (ARDL)-bounds testing approach
by Pesaran et al. [2001. Bounds testing approaches to the analysis of level relationships. Journal of
Applied Econometrics 16, 289326] to examine this linkage. We also use two proxies of energy
consumption, namely total energy consumption per capita and electricity consumption per capita.
The results of the bounds test show that there is a stable long-run relationship between each of the
proxies of energy consumption and economic growth. The results of the causality test, on the other
hand, show that there is a unidirectional causal flow from total energy consumption to economic
growth and a prima-facie causal flow from electricity consumption to economic growth. Overall, the
study finds that energy consumption spurs economic growth in Tanzania.
& 2008 Elsevier Ltd. All rights reserved.
1. Introduction
Since 1970s, a number of studies have attempted to examine
the causal relationship between energy consumption and eco-
nomic growth in both developed and developing countries.
Unfortunately, the majority of the studies in developing countries
have concentrated mainly in Asia and Latin America, affording
sub-Saharan African (SSA) countries very little coverage and in
some instances none at all. In fact, empirical studies on countries
like Tanzania are almost non-existent. Even where such studies
have been undertaken, the empirical findings on the direction of
causality between energy consumption and economic growth
have been largely inconclusive. Over all, the empirical evidence
from previous studies on this subject shows that the causal
relationship between energy consumption and economic growthdiffers from country to country and over time. In addition,
previous studies have shown that the causality between the two
variables may be sensitive to the choice of the energy consump-
tion variable. Although the majority of the previous studies have
found a direct causal relationship between the various proxies
of energy consumption and economic growth, the literature
regarding the possible neutrality between energy consumption
and economic growth is growing in quantity and substance. The
majority of the previous studies on the causality between energy
consumption and economic growth have mainly used theresidual-based cointegration test associated with Engle and
Granger (1987) and the maximum likelihood test based on
Johansen (1988)and Johansen and Juselius (1990). Yet it is now
well known that these cointegration techniques may not be
appropriate when the sample size is too small (see Narayan and
Smyth, 2005). In addition, some previous studies have over-relied
on the cross-sectional data analysis, which generalises the causal
relationship between energy consumption and economic growth
across countries. The problem of using a cross-sectional method is
that by grouping together countries that are at different stages
of economic development, it fails to address the country-specific
effects of energy consumption on economic growth and vice
versa. In particular, the method fails to explicitly address the
potential biases induced by the existence of cross-countryheterogeneity, which may lead to inconsistent and misleading
estimates (see alsoOdhiambo, 2008;Ghirmay, 2004;Quah, 1993;
Casselli et al., 1996). It is against this backdrop that the current
study attempts to investigate the intertemporal causal relation-
ship between energy consumption and economic growth in
Tanzania using the autoregressive distributed lag (ARDL)-bounds
testing approach. The study uses two proxies of energy consump-
tion, namely the total energy consumption per capita and the
electricity consumption per capita against the real GDP per
capitaa proxy for economic growth. The rest of the paper is
structured as follows: Section 2 gives an overview of the energy
policies in Tanzania. Section 3 presents the literature review,
while Section 4 deals with the empirical model specification, the
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Energy Policy
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Energy Policy 37 (2009) 617622
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estimation technique and the empirical analysis of the regression
results. Section 5 concludes the study.
2. An overview of energy policies in Tanzania
The main sources of energy in Tanzania include biofuel, woodfuel, hydroelectric power, natural gas, biogas, coal reserves, wind
and solar energy. However, the most exploited energy source
is wood fuel, which is considered to be cheap and accessible to
the majority of Tanzanians who live mainly in rural areas. In fact,
the biomass energy resource, which consists of fuel-wood and
charcoal from natural forests and plantations, accounts for 90% of
the total energy consumption, while petroleum accounts for 8%
(SARDC, 2006). Petroleum and hydroelectric power on the other
hand, account for 8% and 1.2%, respectively. The remaining energy
sources, such as solar energy, wind, etc. account for only 0.8%. The
vast majority of Tanzanians do not have access to electricity. In
particular, the rural population is hard hit. While about 39% of the
urban population have access to electricity, only 2% of the rural
population have access to electricity. The government of Tanzaniahas implemented a number of policies which are aimed at
addressing the countrys energy needs. Recently, the government
decided to review the countrys energy policy of 1992, which
culminated in the National Energy Policy of 2003. The main aims
of this policy are to: (i) promote affordable and reliable energy
supplies throughout the whole country; (ii) reform the market for
energy services and establish an adequate institutional framework
to facilitate investment in the energy sector, taking into account
the environmental concerns in all energy activities; (iii) enhance
the development and utilisation of indigenous and renewable
(RE) energy sources; (iv) promote energy efficiency and conserva-
tion; and increase energy education and build gender-balanced
capacity in energy planning, implementation and monitoring
(Republic of Tanzania, 2005).
The consumption of energy in Tanzania has, however, shown a
mixed trend, especially since the 1990s. For example, the energy
consumption, measured in kilograms of oil equivalent per capita,
steadily decreased from 428.142 in 1980 to 352.062 in 1994,
before increasing to 358.427 in 1995. Although the consumption
later decreased to 353.185 and 347.882 in 1996 and 1997,
respectively, it later increased again to 360.055 in 1998. Since
1999 the energy consumption in Tanzania has been increasingconsistently, with the highest level of 498.29 since 1973 being
recorded in 2004.Fig. 1shows the trends of energy consumption
per capita and GDP per capita during the period 19942005 as
compared to 1980.
3. Literature review
The causal relationship between energy consumption and
economic growth has important implications from the theoretical,
empirical and policy standpoints. A unidirectional causality
running from electricity consumption to economic growth, for
example, implies that economic growth is dependent on energy
consumption, and a decrease in energy consumption may restraineconomic growth (see also Narayan and Singh, 2007, p. 1142).
A unidirectional causality running from GDP to energy consump-
tion, on the other hand, implies that a country is not entirely
dependent on energy for its economic growth, and that energy
conservation policies can be implemented with little or no
adverse effects on economic growth. Likewise, the finding of no
causality in either direction, i.e. the so-called neutrality hypoth-
esis, implies that energy conservation policies have no effect on
economic growth (seeAsafu-Adjaye, 2000;Paul and Bhattacharya,
2004).
On the empirical front, there exist four views regarding the
causal relationship between energy consumption and economic
growth. The first view argues that energy consumption Granger-
causes economic growth. This view has been widely supported by
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0
5
10
15
20
25
30
1980
Year
Perc
ent
% Change in energy use per capita
% Change in GDP per capita
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Fig. 1. Trends of energy consumption per capita and economic growth during the period 19942005 as compared to 1980. Source: Authors own computation from the
World Development Indicators CD-ROM, 2007; International Financial Statistics Yearbook, 2007.
N.M. Odhiambo / Energy Policy 37 (2009) 617622618
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Narayan and Smyth (2008)for the case of G7 countries;Narayan
and Prasad (2008)for the case Australia, Iceland, Italy, the Slovak
Republic, the Czech Republic, Korea, Portugal and the UK; Narayan
and Singh (2007)for the case of Fiji; Altinay and Karagol (2005)
for the case of Turkey; Wolde-Rufael (2004) for the case of
Shangai;Shiu and Lam (2004)for the case of China;Chang et al.
(2001)for the case of Taiwan; Yang (2000)for the case of Taiwan;
Cheng (1997)for the case of Brazil and Masih and Masih (1996)for the case of India, among others. The second view argues that it
is economic growth that drives the energy consumption in many
countries, and that as the economy grows the demand for energy
from different sections of the economy increases. The empirical
work, which is consistent with this view includes studies such as
Kraft and Kraft (1978)for the case of the USA,Cheng (1999)for the
case of India,Gosh (2002)for the case of India, Narayan (2005);
Narayan and Smyth (2005)for the case of Australia,Abosedra and
Baghestani (1989)for the case of the USA, Cheng and Lai (1997)
for the case of Taiwan, Masih and Masih (1997) for the case of
Indonesia,Hatemi-J and Irandoust (2005)for Sweden, Mozumder
and Marathe (2007) for the case of Bangladesh, among others.
The third view, however, maintains that both electricity con-
sumption and economic growth Granger cause each other, i.e.,that there is a bidirectional causality between electricity con-
sumption and economic growth. This view has been widely
supported by studies such asMasih and Masih (1997)for the case
of Korea and Taiwan, Yang (2000) for the case of Taiwan, Paul and
Bhattacharya (2004)for the case of India and Glasure (2002)for
the case of Korea. Finally, the fourth view maintains that there is
no causality between energy consumption and economic growth.
In other words, these studies assert that energy consumption
and economic growth are neutral with respect to each other.
This finding has been supported by the studies ofAkarca and Long
(1980)for the case of the USA,Yu and Hwang (1984)for the case
of the USA,Cheng (1995)for the case of the USA andCheng (1997)
for the case of Mexico and Venezuela, among others.
4. Estimation techniques and empirical analysis
4.1. CointegrationARDL bounds testing procedure
In this study the recently developed ARDL-bounds testing
approach is used to examine the long-run cointegration relation-
ship between each of the two proxies of energy consumption and
economic growth. The ARDL modelling approach was originally
introduced by Pesaran and Shin (1999) and later extended by
Pesaran et al. (2001). The ARDL cointegration approach has
numerous advantages in comparison with other cointegration
methods. Unlike other cointegration techniques, the ARDL does
not impose a restrictive assumption that all the variables understudy must be integrated of the same order. In other words, the
ARDL approach can be applied regardless of whether the under-
lying regressors are integrated of order one [I(1)], order zero [I(0)]
or fractionally integrated. Secondly, while other cointegration
techniques are sensitive to the size of the sample, the ARDL test is
suitable even if the sample size is small. Thirdly, the ARDL
technique generally provides unbiased estimates of the long-run
model and validt-statistics even when some of the regressors are
endogenous (see also Harris and Sollis, 2003). The ARDL model
used in this study can be expressed as follows:
Model 1total energy consumption and economic growth
DInyt a0 Xn
i1
a1iDInyti Xn
i0
a2iDInENCti a3Inyt1 a4InENCt1 mt
(1)
DInENCt b0 Xn
i1
b1iDInENCti Xn
i0
b2iDInyti b3Inyt1 b4IInENCt1 mt
(2)
Model 2electricity consumption and economic growth
DInyt f0 Xn
i1
f1iDInyti Xn
i0
f2iDInELECti f3Inyt1 f4InELECt1 mt
(3)
DInELECt d0 Xn
i1
d1iDInELECti Xn
i0
d2iDInyti d3Inyt1 d4InELECt1 mt
(4)
where Iny is the log of per capita real GDP; InENCthe log of total
energy consumption per capita; InELEC the log of electricity
consumption per capita; m the white noise error term and D thefirst difference operator. The per capita real GDP data was
computed from the International Financial Statistics Yearbook
(2007), while the total energy data and the electricity consump-
tion were obtained from the World Development Indicators
CD-ROM (2007).
The bounds testing procedure is based on the joint F-statistic
(or Wald statistic) for cointegration analysis. The asymptoticdistribution of the F-statistics is non-standard under the null
hypothesis of no cointegration between examined variables.
The null hypothesis of no cointegration among the variables in
Eq. (1) is (Ho: a3 a4 0) against the alternative hypothesis
(H1: a3aa4a0). In Eq. (2), the null hypothesis of no cointegra-
tion is (Ho: b3 b4 0) against the alternative hypothesis
(H1: b3ab4a0), while in Eq. (3), the null hypothesis of no
cointegration is (Ho:f3 f4 0) against the alternative hypoth-
esis (H1: f3af4a0). Finally, in Eq. (4), where the electricity
consumption per capita is the dependent variable, the null
hypothesis of no cointegration is (Ho: d3 d4 0) against the
alternative hypothesis (H1: d3ad4a0). Pesaran and Pesaran
(1997)and Pesaran et al. (2001)report two sets of critical values
for a given significance level. One set of critical values assumesthat all variables included in the ARDL model are I(0), while the
other is calculated on the assumption that the variables are I(1). If
the computed test statistic exceeds the upper critical bounds
value, then the Ho hypothesis is rejected. If the F-statistic falls into
the bounds then the cointegration test becomes inconclusive. If
theF-statistic is lower than the lower bounds value, then the null
hypothesis of no cointegration cannot be rejected.
4.2. Granger non-causality test
Once the long-run relationships have been identified in
Section 4.1, the next step is to examine the short-run and long-
run Granger causality between the two proxies of energy
consumption and economic growth. The traditional Grangersdefinition of causality is based on the notion that the future
cannot cause the past, but that the past can cause the future
(see also Takaendesa and Odhiambo, 2007). According to
Grangers definition of causality, a time series, Xt, causes another
time series, Yt, ifYt can be predicted better (in a mean-squared-
error sense) using past values ofXtthan by not doing so. That is if
past values ofXtsignificantly contribute to forecasting Yt, then Xtis said to Granger cause Yt. Causality from Y to X can also be
defined in the same way. That is, when past values of Ytsignificantly contribute to forecasting future values ofXt, then Ytis said to Granger cause Xt.
The Granger causality test method has been chosen in this
paper over other alternative techniques because of its favourable
response to both large and small samples. Guilkey and Salemi(1982), andGeweke et al. (1983), for example, have all shown that
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the Granger test outperforms the other methods in both large and
small samples. Other alternative test procedures that have been
suggested in the literature include:Sims (1972),Pierce and Haugh
(1977), and Geweke (1982), among others. The conventional
Granger causality test involves the testing of the null hypothesis
that Xt does not cause Yt and vice versa by simply running the
following two regressions
Yt a0 Xn
i1
a1iYti Xn
i1
b1iXti ut (5)
Xt b0 Xn
i1
a2iYti Xn
i1
b2iXti t (6)
whereut,etare the white noise error processes and n denotes thenumber of lagged variables.
The Null hypothesis that Xt does not Granger cause Yt is
rejected ifb1iare jointly significant (Granger, 1969). Likewise, the
null hypothesis that economic growth does not Granger cause
financial development is rejected if ais are jointly rejected.
However, the traditional causality tests suffer from two metho-
dological deficiencies (see also Odhiambo, 2004). First, these
standard tests do not examine the basic time series properties ofthe variables. If the variables are cointegrated, then these tests
incorporating different variables will be mis-specified unless the
lagged error-correction term is included (Granger, 1988). Second,
these tests turn the series stationary mechanically by differencing
the variables and consequently eliminate the long-run informa-
tion embodied in the original form of the variables. As opposed to
the conventional Granger causality method, the error-correction-
based causality test allows for the inclusion of the lagged error-
correction term derived from the cointegration equation. By
including the lagged error-correction term, the long-run informa-
tion lost through differencing is reintroduced in a statistically
acceptable way. The Granger causality model used in the current
study is based on the following model (see Odhiambo, 2007;
Narayan and Smyth, 2008).Model 1Causality test between total energy consumption
and economic growth
DInyt a0 Xn
i1
a1iDInyti Xn
i0
a2iDInENCti ECMt1 mt (7)
DInENCt b0 Xn
i1
b1iDInENCti Xn
i0
b2iDInyti ECMt1 mt
(8)
Model 2Causality test between electricity consumption and
economic growth
DInyt f
0X
n
i1
f1iDIny
tiX
n
i0
f2iDInELEC
t
i ECM
t
1 m
t
(9)
DInELECt d0 Xn
i1
d1iDInELECti Xn
i0
d2iDInyti ECMt1 mt
(10)
where ECMt1 is the lagged error-correction term obtained from
the long-run equilibrium relationship.
Although the existence of a long-run relationship between
[ENC, y] a n d [ELEc, y] suggests that there must be Granger
causality in at least one direction, it does not indicate the
direction of temporal causality between the variables. The
direction of the causality in this case can only be determined by
the F-statistic and the lagged error-correction term. While thet-statistic on the coefficient of the lagged error-correction term
represents the long-run causal relationship, the F-statistic on the
explanatory variables represents the short-run causal effect
(see Odhiambo, 2008; Narayan and Smyth, 2006). It should,
however, be noted that even though the error-correction term has
been incorporated in all the equations (7)(10), only equations
where the null hypothesis of no cointegration is rejected will be
estimated with an error-correction term (see also Narayan and
Smyth, 2006;Morley, 2006).
4.3. Empirical analysis
4.3.1. Stationarity test
Although the bounds test for cointegration does not require
that all variables be integrated of order 1 [ I(1)], it is important to
conduct the stationarity tests in order to ensure that the variables
are not integrated of order 2 [I(2)]. In fact, the F-test would be
spurious in the presence ofI(2) because both the critical values of
the F-statistics computed by Pesaran et al. (2001) and Narayan
(2005)are based on the assumption that the variables are I(0) or
I(1). The results of the stationarity tests on differenced variables
based on the PhillipsPerron and NgPerron tests are presented in
Tables 1 and 2.The results reported in Tables 1 and 2 show that after
differencing the variables once, all the variables were confirmed
to be stationary. The PhillipsPerron and NgPerron tests applied
to the first difference of the data series reject the null hypothesis
of non-stationarity for all the variables used in this study. It is,
therefore, worth concluding that all the variables used in this
study are not I(2).
4.3.2. Cointegration test
In this section, the long-run relationship between [ENC,y] and
[ELEC,y] is examined using the ARDL bounds testing procedure. In
the first step, the order of lags on the first differenced variables in
Eqs. (1)(4) is obtained from the unrestricted models by using an
Akaike Information Criterion and Schwartz Bayesian Criterion
(see the results of the above tests (not reported here)) show that
the optimal lag for both Models 1 and 2 is lag 2. Having
established the optimal lag length for Eqs. (1)(4), the next
step is to apply a boundsF-test to Eqs. (1)(4) in order to establish
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Table 1
Stationarity tests of variables on first differencePhilipsPerron (PP) test
Variable No trend Trend Stationarity status
DLy 10.1436*** 4.1167** Stationary
DLENC 3.6053** 6.2966*** Stati onary
DLELEC 6.0846*** 5.9431*** Stati onary
Note: (1) the truncation lag is based on Newey and West (1987)bandwidth.
(2) **and ***denote significance at 5% and 1%, respectively.
Table 2
Stationarity tests of variables on first differenceNgPerron test
Variable NgPerron test statistics (with trend) Stationarity status
MZ MZt MSB MPT
DLy 34.1774 3.94463 0.11542 3.68770 Stationary
DLENC 78.8378 6.26157 0.07942 1.22526 Stationary
DLELEC 66.7107 5.77029 0.08650 1.38849 Stationary
Asymptotic critical values(Ng and Perron, 2001,Table 1)
1% 23.8000 3.42000 0.14300 4.03000
5% 17.3000 2.91000 0.16800 5.48000
10% 14.2000 2.62000 0.18500 6.67000
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a long-run relationship between the variables under study.
The results of the bounds test are reported inTable 3.
The results reported in Table 3show that when the real GDP (y)
per capita is used as the dependent variable in Model 1 and Model
2, the calculatedF-statistic is higher than the critical value at 10%
and 5% levels, respectively. However, when the total energy
consumption (ENC) in Model 1 and electricity consumption (ELEC)
in Model 2 are used as dependent variables, the calculatedF-statistics are lower than the lower-bound critical values at the
10% level. This implies that there is a unique cointegration vector
in Model 1 and also in Model 2.
4.3.3. Analysis of causality test based on error-correction model
Having found that there is a long-run relationship between
[y, ENC] in Model 1 and [y, ELEC] in Model 2, the next step is to
test for the causality between the variables used by incorporating
the lagged error-correction term into Eqs. (7) and (9), respectively.
The causality in this case is examined through the significance
of the coefficient of the lagged error-correction term and joint
significance of the lagged differences of the explanatory variables
using the Wald test. The results of these causality tests are
reported inTable 4.
The empirical results reported inTable 4show that there is a
distinct unidirectional causal flow from total energy consumption
to economic growth, both in the short run and in the long run
(see Model 1). The long-run causality from total energy con-
sumption to economic growth is supported by the coefficient
of the lagged error-correction term in the economic growth
function, which is negative and statistically significant, as
expected. The short-run causality from total energy consumption
to economic growth, on the other hand, is supported by the
F-statistic in the economic growth function, which is statistically
significant. The reverse causality from economic growth to total
energy consumption, however, is rejected by the lagged error-
correction term and the F-statistic in the energy function, which
are all statistically insignificant. The results also show that there is
a prima facie (short-run) causal flow from electricity consumption
to economic growth (see Model 2). The short-run causal flow from
electricity consumption to economic growth is supported by the
F-statistic in the economic growth function in the second model,which is statistically significant. The long-run causal flow from
electricity consumption to economic growth is, however, rejected
by the lagged error-correction term in the economic growth
function (Eq. (7)), which is statistically insignificant. A summary
of the causality test between the three variables is presented in
Table 5.
5. Conclusion
This study examines the intertemporal causal relationship
between energy consumption and economic growth in Tanzania
using two proxies of energy consumption, namely total energy
consumption and electricity consumption against per capita real
GDPa proxy for economic growth. The study attempts to answer
one fundamental question. Does energy consumption in Tanzania
spur economic growth? Although a number of studies have been
conducted on the causal relationship between energy consump-
tion and economic growth in a number of developing countries,
the majority of these studies have concentrated mainly on Asia
and Latin America, affording sub-Saharan African (SSA) countries
very little coverage and in some instances none at all. In addition,
previous studies on this subject suffer from two major weak-
nesses. Firstly, the majority of the previous studies have mainly
used the residual-based cointegration test associated with Engle
and Granger (1987)and the maximum likelihood test based on
Johansen (1988)andJohansen and Juselius (1990)to examine the
relationship between energy consumption and economic growth.Yet it is now well known that these cointegration techniques may
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Table 3
Bounds F-test for cointegration
Dependent variable Function F-test statistic
Model 1Total energy consumption and economic growth
y y(ENC) 3.799*
ENC ENC(y) 2.550
Model 2Electricity consumption and economic growth
y y(ELEC) 5.540**
ELEC ELEC(y) 1.026
Asymptotic critical values
1% 5% 10%
I(0) I(1) I(0) I(1) I(0) I(1)
6.027 6.760 4.090 4.663 3.303 3.797
Note: ** and * denote statistical significance at the 5% and 10% levels, respectively.
Asymptotic critical value bounds are obtained from Narayan (2005), p. 1987,
Appendix: Case II.
Table 4
Granger non-causality tests
Dependent variable Causal flow F-statistic t-Test on ECM R2
Model 1Total energy consumption and economic growth
Economic growth (y) Total energy consumption (ENC)-economic growth (y) 3.3674 (0.0208)** 2.044** 0.43
Total energy consumption (ENC) Economic growth (y)-total energy consumption (ENC) 9.3042 (0.0003)*** 0.77
Model 2Electricity consumption and economic growth
Economic growth (y) Electricity consumption (ELEC)-economic growth(y) 3.600 (0.0339)** 0.973 0.37
Electricity consumption (ELEC) Economic growth (y)-electricity consumption (ELEC) 0.95318 (0.4761) 0.24
** and *** denote statistical significance at 5% and 1% levels, respectively.
Table 5
Summary of causality tests
Variables Causality General conclusion
Economic growth
(DLy) and total
energy
consumption
(DLENC)
There is a distinct
unidirectional causal flow
from energy consumption to
economic growth.
Energy consumption
Grangercauses economic
growth.
Economic growth
(DLy) and
electricity
consumption(DLELEC)
There is a short-run
unidirectional causal flow
from electricity consumption
to economic growth.
Electricity consumption
Grangercauses economic
growth only in the short run.
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not be appropriate when the sample size is too small (see Narayan
and Smyth, 2005). Secondly, some previous studies have over-
relied on the cross-sectional data analysis, which fails to address
the country-specific effects of energy consumption on economic
growth and vice versa. Using the ARDL-bounds test procedure, the
empirical results of this study show that there is a distinct
unidirectional causal flow from total energy consumption to
economic growth, both in the short run and in the long run. Theresults also show that there is a prima facie(short-run) causal flow
from electricity consumption to economic growth. Overall, the
study finds that energy consumption spurs economic growth in
Tanzania.
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