The economics of the circular economy

Economic Fiscal Reform calls for the economic system to align with the twin purposes of preserving and  indeed restoring the environment whilst providing a standard of living for citizens. Up to now, these purposes have not been central to the way economics has been practiced. We are, however, facing a pressing situation: soil degradation, atmospheric warming and mineral depletion are forcing us to rethink. The idea of the circular economy – where biological and mineral material circulate in the economy without being deposited – is gaining ground.

To be  a useful tool to the circular economy, economics needs to  develop a circular framework. In other works, for this Environmental Fiscal Reform to be effective, economists need to be better able to quantify and qualify the transition from the linear, fossil-based economy to a circular, renewable energy –based economy.

This essay aims to contribute to the development of a terminology, represented mathematically, that provides a  political economic framework.  It is hoped that this framework will be helpful to those working with Environmental Fiscal Reform and those modeling sustainable circular economic systems.

At the end we present a circular economy profit and loss statement and balance sheet.

The Circular economy

Distinguishing between biological and technical nutrients

The circular economy approach classifies all materials entering the economy as either biological, originating from the biosphere, or technical, originating from the mineral or rock layer of the Earth.

Borrowing from biological terminology, these materials, in raw form or indeed incorporated in products are designated  biological nutrients (“feeding or nourishing” ecosystems) or technical nutrients (“feeding or nourishing” industrial systems).

Differences between Biological and Technical Nutrients

The nutrients coming from the biological layer of the Earth are non-depleting. However, from the point of view of the need for humans to have access to productive land,  they can be either relatively abundant or scarce.  For example, for the main components of NPK fertilizer, nitrogen(N) is abundant and phosphorus(P) is scarce.

The biological layer of the Earth can be seen as a pool from which these nutrients come and go in various forms.  The term pollution in this case refers to an accumulation of nutrients that reaches concentrations so high that the functioning of the recipient is reduced. Pollution with biological nutrients implies congestion:  too many in the wrong place and/or at the wrong time. For example, high concentrations of nitrogen and phosphorus in lakes reduce fish populations and the supply of fresh water. And concentration of nutrients in one place implies a lack in others.

Technical nutrients come from  under the biological layer (from rock, gravel, sand etc). Examples include iron, cadmium and aluminium. Once removed from the source (typically by mining) the potential recoverable reserves are reduced by the amount removed. Once in the economy, they can of course be recycled and as such can be seen as a permanent resource.  Obvious exceptions are substances used  as fuel, like oil, coal and radioactive material. Once burnt or reacted, they cannot be used as an energy source again.

Although technical nutrients can be recycled,  the worst case scenario is where they are released from the economy to some form of waste deposition. Typically, metals that could otherwise be recycled are in an alloy or another  composition with other elements in forms that cannot be recycled.

Pollution with technical nutrients comes from the presence in ecosystems, hydrological systems or in climate systems. For example, carbon from burning fossil fuels can alter heat retention of the atmosphere, and some heavy metals can poison ecosystems.

Why use the term “nutrient”?

The term “nutrient” is preferable to the term “product” because it helps clarify the different stages of the cycle from raw material to final product. Firms sell to other firms all the time, their systems designate what they sell as a product so all components of the supply chain are designated as products by them. However, we propose reserving a versions of the term “product” for something that is sold to the end-user that is typically charged VAT.

Potentially extractable nutrient >nutrient in the economy>nutrient in product

The registered VAT transaction is a system boundary which products and services cross when they are sold to the end consumer.  Up to that point, businesses selling to other businesses recover VAT. This is important for gaining a view of the functioning of the economy: without a demand from a private citizen being fulfilled, the long chain of business to business has no meaning.

From a circular economy point of view the distinction is needed. Nutrients need to be with consumers rather than locked in supply chains or waste deposits. Being able to identify their location in the economy could be one of the keys to reducing pollution and increasing efficiency of nutrient use and recycling.

The other point about distinguishing products and nutrients is that the purpose of the economy is to provide for people. The amount of product  reaching people is the focus, rather than the amount of product being bought and sold company to company.

This end-user transaction is the one that drives the whole supply chain, and the distinction is therefore useful, especially as a circular economy predicates new designs of products and services where biological and technical nutrients are used in a responsible manner.

Identifying the status of the technical nutrient

Supply chains can consist of extremely long chains of firms from those extracting raw materials to those producing components, then selling and finally recycling. For modeling purposes we need to identify the state of the technical nutrient as being in:

  • Potential recoverable resource
  • Raw material
  • Material
  • Component
  • Part
  • Finished product
  • Scrapped as Waste
  • Scrapped ready to be recycled

Circularity of technical nutrients comes when products are:

  • not scrapped but repaired
  • broken down to refurbished/reusable materials, components , or parts

The view of the firm

A generalized view of the firm is one where: energy and materials come in. Using infrastructure (capital) and labor, a product and or service is produced that is sold, the money from the sale covering the purchase of labor and materials as well as capital infrastructure.

A certain amount of waste is generated that goes to waste handling services or in the worst case, goes uncontrolled into the eco-system or as landfill.

A simplified approach using the Cobb-Douglas equation gives:

\ Y = L\cdotp K

Where Y = output and L= Labour and K = capital

An energy- and material aware equation would be

\ Y = Labour\cdotp Capital\cdotp Energy\cdotp Materials 

Defossilisation

For the firm to defossilise, the energy sources need to be switched to renewable, and the capital infrastructure needs to be adapted to use renewable energy and materials too.

To better represent this we take, KRenewable  (KR) to mean the Capital infrastructure – machines and other operating equipment – that operates to handle materials is a circular way.
For example, machines that use recycled materials, or produce packaging that can be recycled, can be designated KR.
The opposite is KLinear (KL) – where machinery uses extracted material and produces waste that cannot be recycled.

ERenewable represents the energy used in production from renewable sources (ER). The opposite is Non-renewable energy (EN)
M reCycled represents the material incorporated into the product from recycled sources and goes to back to reuse (MC). Non-recycled material is designated (ML) where L represents the linear material use.

Linear, non-renewable production can be represented thus:

\ Y_Linear = L\cdotp K_L \cdotp  E_N\cdotp M_L

Circular, renewable energy-driven production can be represented as

\ Y_Circular = L\cdotp  K_C \cdotp  E_R \cdotp M_C

In the transitional phase firms will probably have a combined production

\ Y = L\cdotp ( K_L+K_C )\cdotp(E_R +E_N)\cdotp(M_L+M_C)

A measure of circularity can be created from calculating the fraction of renewable – running infrastructure, the fraction of renewable energy and the fraction of recycled materials.

\ Y = L\cdotp \frac{K_C}{( K_L+K_C )}\cdotp\frac{E_R}{( E_R+E_N )}\cdotp\frac{M_C}{( M_L+M_C )}
The circular balance sheet.

From the above we can envisage a balance sheet from which it is possible to glean the current state of the firm’s investment in circularity. A worked example is given below.

THE TRANSITIONAL COMPANY
PERIOD ENDED 31/12/2016
CURRENT ASSETS CURRENT LIABILITIES
Cash 200 000 € Accounts payable 0 €
Accounts receiveable 0 € Accrued Expenses 0 €
Inventory 0 € Taxes owed 0 €
TOTAL CURRENT ASSETS 200 000 € Long term debt 0 €
TOTAL CURRENT ASSETS 0 €
PROPERTY AND EQUIPMENT
*Circular Infrastructure 100 000 € LONG TERM DEBT
*Non-circular Infrastructure 50 000 € *Loans for Circular investment 100 000 €
Less depreciation -4 000 € *Loans for other infrastructure investment 30 000 €
NET FIXED ASSETS 146 000 € Other loans
TOTAL LIABILITIES 130 000 €
OTHER ASSETS STOCKHOLDERS EQUITY
Licence 0 € Paid in Capital 0 €
Goodwill 0 € Retained Earnings 0 €
TOTAL OTHER ASSETS 0 € TOTAL NET WORTH 0 €
TOTAL ASSETS 346 000 € TOTAL LIABILITIES AND NET WORTH
*Percentage circular infrastructure value 67% *Percentage investment loans for circular infrastructure 77%

An extended profit and loss statement can also be created as shown below.

From this you can derive measures like % of sales of circular products, cost of circular technology, circular vs non-circular expenses and trends over time

INCOME STATEMENT
PERIOD ENDED 31/12/2016
CURRENT
OPERATING INCOME
*Circular product sales 50 000 €
*Non-circular sales 100 000 €
Net sales 150 000 €
*Renewable energy 2 000 €
*Non-renewable energy 2 000 €
*Non-circular materials purchase 2 500 €
*Circular materials purchase 2 500 €
Other costs of good sold 100 €
GROSS INCOME 140 900 €
OPERATING EXPENSES
*Renewable energy 2 000 €
*Non-renewable energy 4 000 €
*Non-circular materials purchase 3 000 €
*Circular materials purchase 10 000 €
*Repairs and maintenance on linear infrastructure 20 000 €
*Repairs and maintenance on circular infrastructure 30 000 €
*Costs for waste elimination, non-recycled 2 000 €
Other expenses
TOTAL OPERATING EXPENSES 71 000 €
Other income 0 €
Other expenses 0 €
NET INCOME BEFORE TAXES 69 900 €
TAXES 25 000 €
NET INCOME 44 900 €
Circular products 50/150    75%

Renewable energy 2/6        50%

Circular materials 10/13     77%

Circularity lost to waste    15%

Circular infrastructure

costs 30/50                           60%

In coming essays we hope to discuss how to use economic instruments to drive circularity and to use this framework to explore economic measures of the performance of the economy in terms of to what extent it is fulfilling the purpose of providing for people and caring for the environment.

READ MORE

Advertisements
%d bloggers like this: