Circular economy

True pricing is not enough to make an economy circular

Column

Circular economy is widely viewed as the solution for many sustainability issues, such as climate change. In this Week of the Circular Economy, Hans Stegeman acknowledges it as such, but warns for a simplification of the whole concept. Achieving something resembling a circular economy goes way beyond true pricing and requires many fundamental changes, not the least in our (economic) thinking.

CPB, the Netherlands Bureau for Economic Policy Analysis, recently stated that if pollution was made more expensive, we would arrive at a circular economy sooner. Pricing environmental damage is of course a very old idea. But if the solution is that simple, why has that not happened yet?

In my view, this idea presented by CPB is based on a number of simplifications and misconceptions. First of all, in many cases pricing is virtually impossible. And what is more, this is not nearly the most complicated element of the circular economy. And finally, in total contrast to the principle of linear economic thinking: nature calls for a healthy dose of wastage and at the same time ensures that there are natural limits to economic activity.

So, putting a price on pollution is all very well, but let's not think that this makes our economy sustainable.

A linear solution for a circular economy

The literature on the circular economy often refers to the linear economy. Now, as an economist I did not know until recently that I was a linear thinker. What this means is that we usually treat materials and commodities in a ‘linear’ fashion: we take raw materials from nature, turn them into a product or consume them, use the product and throw it away. In other words: take, make, use, dispose.

Our market economy is based on such linear actions. But, as CPB argues, these markets are not yet efficient, because scarcity of materials is not priced right and producing waste and emitting CO2 in fact costs nothing at all.

If we organise this in the right way, says CPB, these ‘externalities’ will automatically diminish. Because if fossil-based resources become more expensive, they will be treated with more care and more sustainable alternatives will become more attractive. If non-sustainable products become more expensive, consumers will continue to use them for longer or will switch to more sustainable alternatives.

A transition to a circular economy requires more than solving organisational and pricing issues. It also calls for a change in mentality.
Hans Stegeman, Head of Research and Investment Strategy

This makes pricing a panacea that will make the economy sustainable. Independent research and consultancy organisation CE-Delft has calculated  over 1,000 of this sort of ‘correct’ prices. More maths: PBL, the Netherlands Environmental Assessment Agency, has recently calculated  that the annual environmental damage in the Netherlands amounts to around EUR 31 billion. This is just over EUR 1,800 per capita.

The linear limitation of the circular economy

This pricing approach is based on a number of assumptions: markets are efficient, price incentives solve everything and creating a circular economy requires only limited adjustments. I have my doubts about all of these ideas.

For a start, pricing is in actual fact a very complicated process. PBL has indeed estimated that the environmental damage averages EUR 31 billion, but actually gives a range of EUR 16 billion to EUR 49 billion. In other words: we believe that the environmental damage costs EUR 1,800 per capita, but it might also be EUR 900 or EUR 2,800.

This can hardly be used as a market price. The market really will not solve this just like that. I will go even further than that: we see that companies are very successful at preventing pricing of environmental damage.

Furthermore, the pricing solution is a prime example of a ‘drawing board’ approach. What is overlooked here, is that circular markets can often not solve anything at all, because there is no market (yet) or the market is so limited that the pricing process does not result in the correct prices.

Circular economy

Making material flows circular is a complicated organisational issue. During a transition to a circular economy this creates huge challenges, because the aim is not to maximize value in market transactions, but to preserve the value of resources and products.

Here is an example. The circular economy calls for the development of ‘secondary markets': markets for used goods, renewable resources, etc. In the early phase, the level of supply and demand on new markets is usually very limited and there is a considerable degree of interdependence between the two. This makes the potential of such markets very uncertain. So, pricing alone is not the solution in such situations.

Third: a transition to a circular economy also calls for a change in mentality. CPB itself also notes this in another report. Elements of behavioural economics plays an important part here. Consumers are not focused on maximising value preservation. They simply want something new every once in a while. And second-hand goods are just not as attractive as new ones.

The circular challenges for the circular economy

All this was still the way of thinking in the standard economists’ paradigm, that is based on the principle of efficient markets. But now we are taking things one step further. In a circular economy, the aim is to operate within the limits of nature. Often the comparison is therefore made with natural processes, based on the natural cycle. And that creates two problems.

First, efficiency. If we focus only on efficient markets, innovation is held back, and the resilience of the system is thus also reduced. Natural processes involve a lot of waste. Of all the seeds that are planted, only a limited number germinate. Trees lose their leaves and many animals die through natural selection.

Nature exists by the grace of waste as an input for other cycles, which is very effective, but not efficient. A system that is fully focused on efficiency lacks exactly that input for other cycles and is therefore not resilient.

And: wastage can also prove a breeding ground for transitions. The electric bicycles that we now see on our Dutch roads have as yet little to do with sustainability, because it is mainly older people that use them instead of normal bicycles.At the same time, however, a market is being created, which enables manufacturers to invest in improving the performance of the batteries. In time, this will result in bikes that are also suitable for commuters and can therefore become an alternative for cars. This development is not efficient, but it is effective.

The second ‘tricky issue’ is the natural limit. The most important thing that we can learn from nature is that there is a natural limit and that nature is regenerative and adaptive. Unfortunately, an economic and efficient system does not adapt and regenerate itself. Not even with correct pricing. This natural limit implies that we need to consume less and will have to adapt the scale of our system as a whole.

But that is still a long way off. And maybe we should welcome the call for pricing. It is at least a start.

Related articles