# **I. Introduction**

The Eastern Europe and Central Asia region had one of the least efficient manufacturing sectors in the world because of the region’s historical emphasis on heavy industries and artificially low energy prices during the Soviet era.<sup>3</sup> Since the transition period started two decades ago, the sector’s energy productivity (value added per unit of energy input) has consistently improved – by almost 35 percent between 1998 and 2008. As a result, although manufacturing value added increased by more than 50 percent over the period, energy consumption had been stabilized at around 250 million tons of oil equivalent (mtoe). How did the region achieve this impressive decoupling of economic growth from energy use? This paper seeks to answer the question by empirically examining the trend and determinants of manufacturing energy use for 28 countries in ECA.<sup>4</sup> Using detailed sector and country-level data, we conduct three types of analysis. First, we compare energy productivity performance over time and across countries. We ask the following questions: Is the trend of declining energy intensity consistent across the region? Do lagging countries catch up with technological leaders? Second, we decompose the manufacturing sector into 11 subsectors and investigate whether the reduction in energy intensity is more attributable to changes in the mix of production activities (the structural effect), or to the fundamental improvement in the use of energy (the efficiency effect). Finally, we identify the economic factors that have driven changes in energy intensity, energy efficiency and the structural composition of industrial activities.

The analysis reveals strong evidence of cross-country convergence: not only the inter-country variation in energy intensity has reduced; but there is also a tendency of more rapid improvement in countries that had high energy intensity initially. Beyond this general trend, we find some Central Asian countries are notable exceptions where energy intensity had remained largely unchanged. Interestingly, intrinsic efficiency improvement turns out to have contributed to most of the reduction in manufacturing energy intensity, whereas structural change had had a less influence, and had led to higher energy intensity in some countries.

Country-level analysis indicates that rising per capita income and higher energy prices are strong predictors of more efficient energy use, both through the channel of efficiency rather than structural mix. A one percent increase in per capita GDP is on average associated with a 1.3

> 3 Manufacturing consists of all industrial activity outside of mining and construction. The detailed composition of manufacturing industry is described in section III.

> 4 Following the definition of World Bank regions, Eastern European and Central Asia includes Albania, Armenia, Azerbaijan, Belarus, Bosnia & Herzegovina, Bulgaria, Croatia, the Czech Republic, Estonia, Georgia, FYR Macedonia, Hungary, Kazakhstan, Kosovo, the Kyrgyz Republic, Latvia, Lithuania, Moldova, Montenegro, Poland, Romania, the Russian Federation, the Slovak Republic, Slovenia, Tajikistan, Turkey, Turkmenistan, Ukraine and Uzbekistan. Kosovo and Montenegro are not included in the analysis because energy consumption data are not available for these two countries.

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