Unveiling the effects of state capacity on energy diversification in developing countries

Abstract

Despite increasing scholarly attention on the determinants of energy diversification, the importance of state capacity remains under-examined, especially in developing countries. In this paper, we analyze how the fiscal and legal dimensions of state capacity affect energy diversification in 135 developing countries over the period 1990–2020. Employing robust econometric estimation methods, including system GMM, the Lewbel estimator, and the Sequential Linear Panel Dynamic Model (SLPDM), together with mediation analysis, we identify the transmission channels through which state capacity influences energy diversification and find that state capacity plays a crucial role in promoting energy diversification and that this effect is particularly strong in upper-middle-income countries. In addition to the direct effect, state capacity further facilitates energy diversification through three transmission mechanisms: financial development, R&D, and human capital accumulation. This paper adds to the literature by empirically disentangling the impact of two distinct dimensions of state capacity—fiscal and legal—beyond aggregate institutional measures. In doing so, the analysis emphasizes that strengthening state institutions is a necessary condition, rather than merely a politically desirable outcome, for achieving a sustainable energy future. Policy recommendations should therefore be adapted to the level of development: strengthening foundational legal institutions in low-income countries, while leveraging fiscal resources for targeted green investments in middle-income countries.