Can market forces alone create a circular economy?

In recent years the circular economy has emerged as something of a new Holy Grail for the resource sector. The European Commission has joined the quest and we currently await its revised circular economy package. In the literature, one frequently comes across the argument that a transition to a circular economy will be inevitable as businesses respond to rising commodity prices and increased price volatility, driven by rising demand coupled with resource scarcity. This, it is claimed, will start to make the business case for the circular economy increasingly self-evident.

The notion is attractive for its simplicity and because it places the onus on businesses to respond to the price signals without the need for external intervention. Defra no doubt followed this line of thinking in its 2013 Waste Prevention Plan for England when it asserted that:

“We believe a more sustainable and circular economy can and should be delivered with limited government intervention as industry responds to the clear business case for action”.

Appealing though the idea is, can we simply rely on market forces to bring about a circular economy, without external support or guiding policies?

Pricing up the circular economy

We can examine how clear the business case for action actually is (or is likely to be in the future) by asking whether commodity prices and price volatility are indeed increasing. The answer will have implications for whether additional efforts may be required to encourage businesses to adopt circular economy principles and remove barriers to their doing so.

Analysis conducted by McKinsey has suggested that:

“…the turn of the millennium marked the point when real prices of natural resources began to climb upwards, essentially erasing a century’s worth of real price declines”.

It is clear that there was a significant spike in commodity prices over the first decade of the 21^st century. However, the G20 Study Group on Commodities has reported that:

“Recent trends in the price level and volatility of major commodity groups appear less unusual in a long term perspective. In real terms, the level of many commodities is still below their averages in the first decades of the post-war era and well below their historical highs and it is not clear whether the recent increase marks an end, or even a reversal, of the secular decline in real commodity prices observed during the last century”.

More recent data from the International Monetary Fund (IMF) makes it clear that the increase was only temporary. It would seem that many prices are now steadily declining, and it is not yet clear how long this trend may continue. The reality then is that, despite what some would have us believe, we have not entered a phase of ever rising commodity prices and it is anybody’s guess when such a phase will arrive.

A historical perspective indicates that market forces do not always yield wise long term decisions. Image by Brueghel the Younger, via Wikimedia Commons.

The difficulty with relying on commodity price increases as a driver is that the case for change is instantly undermined if prices start to fall. A clear example comes from secondary plastics: in recent months this market has been substantially undermined by the falling price of oil, which has significantly reduced the cost of producing primary polymers. When the cost of using primary materials is low there is little economic incentive to invest in new measures to improve the circular flow of materials through the economy.

Volatile behaviour

Price volatility has been cited as another important driver behind the circular economy. The Ellen McArthur Foundation, for example, has claimed that:

“…price volatility levels for metals, food and non-food agricultural output in the first decade of the 21^st century were higher than in any single decade in the 20^th century. If no action is taken, high prices and volatility will likely be here to stay if growth is robust, populations grow and urbanise, and resource extraction costs continue to rise”.

A number of reports have been published in recent years which note significant volatility in commodity markets since the turn of the century. However, when viewed historically, the level of volatility does not appear to be a uniquely 21^st century phenomenon. Indeed, many of these reports directly contradict much of the circular economy literature, which repeatedly suggests that price volatility has been on the rise.

Detailed analysis of 45 individual commodities by the World Bank provides an interesting starting point:

“…the evidence suggests that structural breaks marking increased price volatility are subsequently followed by downward breaks in volatility so that there is no upward or downward trend in volatility over time”.

This, and a number of other reports (including this one from the OECD) would suggest that the current level of volatility is not unprecedented. If volatility has not increased above levels experienced over the longer-term then it is hard to see how this will act as an explicit driver going forward.

It would appear then, based on the available evidence, that rising commodity prices and price volatility are unlikely to suddenly provide companies with a “clear business case for action” (at least not in the short- to medium-term). Although there is general agreement that the transition to a circular economy will result in environmental benefits and improved resource security, these macro-level benefits seldom provide a clear case for individual companies to adopt business models based on circular economy principles.

Made to measure

In the absence of clear price signals it will be necessary to address market failures and remove barriers to action. Key measures to help drive the circular economy forward could include, for example:

• Getting the “prices right” by introducing taxes aimed at internalising the full environmental and social cost of extracting and producing primary raw materials;
• Improved producer responsibility which encourages manufacturers to design products with recovery in mind;
• Charging a lower rate of VAT on products that have been remanufactured or reused;
• Providing support for companies willing to adopt circular business models and improve the design of their products;
• Incentivising businesses to make use of reused, refurbished, and recycled products and/or materials;
• Engaging consumers by encouraging alternative consumption and ownership habits (e.g. promoting rental over outright ownership);
• Investing in the infrastructure necessary to embed efficient and innovative reverse logistics systems into our economies; and
• Introducing deposit refund schemes to encourage the return of products (e.g. beverage containers and small WEEE).

These measures would, in my view, provide a far more certain means of encouraging change than will the vagaries of commodity prices. It is not the turbulence of markets, but a well formulated policy approach that will ultimately make the business case for action clear to all, and begin to deliver the benefits of a circular economy for business and the environment alike.