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What is the link between power and economic development?

december 6, 2017

Senegal generated about 3,600 GWh of electricity in 2016. This is just about enough to power one fridge for every 4 of its people.

Despite improvements brought to the sector in the recent years, the country’s power sector is still hindered. The average per capita electricity consumption there is 14 times lower than the global average.  Local businesses regularly quote the state of the power system as one of the biggest obstacles for their operations. This is not surprising since they pay more than double for electricity compared to the global average ($0.24 versus $0.10 per kWh).

Senegal is not the only country facing such infrastructure issues. Insufficient power supply and crippling cost of electricity are hurting industries across many developing countries. Businesses need electricity to function, grow, and create jobs and opportunities for people to improve their livelihoods. But how does a new power plant actually help this happen, and how much growth can power projects deliver?

We have investigated this question with a number of development finance organizations, amongst which IFC, CDC, Proparco, and most recently the Private Infrastructure Development Group (PIDG) in Senegal.

There are two pathways through which additional power capacity can affect companies – decreasing the price of electricity and/or reducing the duration of electricity outages. Lower prices and fewer power outages enable companies to increase electricity use and consequentially produce more. Higher production levels mean higher demand for goods and services used in production processes. This benefits local suppliers – including ones that might themselves not be using electricity (such as agriculture producers). The result is higher economic activity, which brings employment opportunities, salaries, tax payments, and profits, leading to higher GDP levels.

To quantify these effects, we use a combination of power-sector and firm-level data integrated into micro- and macro-economic techniques. We gather information from the national utility companies to analyse the extent to which blackouts have been reduced by new power plants. We quantify how more capacity affects electricity tariffs by constricting national supply-demand models showing the price of electricity at each level of power demand. Econometric analysis of business survey data allows us to understand how changes in tariffs affect electricity consumption and firm production levels. Finally, we use input-output modelling to trace how higher production in one sector creates spill-over effects in other industries and affects value added and job creation. Our research has shown that the impact of power investments goes beyond the utility companies themselves. It takes place primarily in the value chains of local businesses that rely on electricity for production.

In our work for PIDG in Senegal, we established that the price pathway is central. The two power projects in which PIDG has invested – a 96MW heavy fuel oil plant providing base load and 20 MW solar – expanded the effective capacity of the grid by 13%. By adding base load cheaper than emergency diesel plants and competitively priced solar respectively, the two plants are estimated to decrease the weighted average generation costs in the country by 12.6%. This will lead to 6.3% decrease in the final consumer tariff in the long-run, provided that the tariffs are cost-reflective. The decrease in electricity prices will enable firms to increase their electricity consumption and consequently production. In fact, we found out that businesses in Senegal are quite sensitive to tariff changes – 1% decrease in electricity price leads to 0.3% -- 0.4% increase in production. The resulting employment effect is estimated at 68,500 jobs, of which 49,700 at manufacturing and service industries which depend on electricity, and 18,800 in agriculture. The results represent headcount/people affected rather than full-time equivalent due to wide-spread underemployment in Senegal (27% of total employment).

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We explored the outages pathway in out 2016 assessment of the power market in Uganda. There, 250 megawatts (MW) of hydro capacity was added to the grid with the completion of the Bujagali dam in 2012. Meanwhile, the privatised distributor Umeme worked hard to reduce distribution losses in the grid. The result was a reduction of outages from 28 hours a month to 12 hours. We estimated that by increasing the time companies can operate, this drop in electricity stimulated economic activity and contributed to over 200,000 job and livelihood opportunities across firm’s value chains.

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Given that these studies are based on data-intensive modelling techniques, the results are dependent on the quality of the statistics used. With these assessments we do not claim to have the ultimate answer on the exact number of jobs supported through infrastructure projects. What our findings do is give investors perspective on the pathways through which they affect local economic development, and on the magnitude of these effects. With such insights, financing institutions are better positioned to undertake the interventions which would allow them to achieve their missions.