An alternative route to a circular economy?

Much is often made of the continuing rise of the Chinese and Indian middle classes.

As their incomes rise, they are anticipated to demand Western-style standards of living, competing for resources and pushing up prices. Higher resource prices will drive businesses to adapt business models and take greater ownership of these resources. In this way, so it is argued, a circular economy will be developed.

(If these global mega-trends really do come to pass though, then there seems to me little need for policy intervention. Economic forces alone will drive us to a circular economy. This though is not the message that seems to come from those who have seen the future.)

I have an alternative view. I agree that rising incomes in the developing world will be a significant driver of change and will help develop a more circular economy here in the West. I however think that the principal driver for this will be a process known as factor price equalisation, rather than higher resource prices.

I have argued before that, while real resource prices have indeed risen considerably in the past decade, this has been slower than rises in incomes. This means that the prices of resources relative to labour have actually continued to decline over time. Globally, people today can afford to buy a (two and half times) bigger basket of resources with their labour than they could 30 years ago. We are already witnessing a weakening of global commodity markets and I expect the overall trend of falling relative prices to continue into the future.

What will change though is that China's cheap labour advantage will be eroded. Some analysts believe that this source of competitive advantage could disappear as soon as 2015. If other elements of Western manufacturers' cost base (to which I will return later) are also competitive then we could expect a repatriation of manufacturing activity as businesses seek to get closer to large, fast moving consumer markets.

In this way, domestic demand for resources, which is currently low, may be expected to rise in the future. But if the relative prices of resources continue to fall as I expect, then by what process could recyclate supplies increase to meet this demand?

I think that the principal driver in this instance will be regulation, not economics. Waste policy (particularly in Europe) will continue to drive up waste management costs. This will in turn drive the supply of recyclates at increasingly competitive prices and specifications. Increasing producer responsibility will incentivise firms to design products which are easier to dissassemble and recycle. The supply of secondary resources will rise and become an important feedstock to the increasing levels of domestic manufacturing activity.

We currently recycle more material than our domestic industries can use. I believe that factor price equalisation could lead to the increasing repatriation of industry which would change this dynamic and close the material loop more locally. But what could undermine this process? I have focused above on labour costs, which will be eroded as developing world incomes rise. Energy costs, however, are increasingly influenced by domestic policies and are likely to be a persistent source of competitive disadvantage to UK manufacturers.

Decc's own analysis suggests that energy policies could increase some manufacturers' bills by up to 20% by 2020. This will continue to make the UK a difficult destination for manufacturers. Unless this is resolved, we will not close the material loop in the UK but will continue to rely on overseas demand for our discarded materials. It is in this area that the proponents of a domestic circular economy should focus their attention.