An Introductory Note on the Environmental Economics of the Circular Economy

An Introductory Note on the Environmental Economics of the Circular Economy

Mikael Skou Andersen

https://doi.org/10.1007/s11625-006-0013-6

Retrieved from: Sci-Hub

The circular economy is a conceptual framework that addresses the interlinkages of the four economic functions of the environment. Unlike the conventional open-ended economy, where resources flow linearly from production to consumption and finally to utility, a circular economy accounts for the relationship between resource use and waste residuals. Based on the first law of thermodynamics, this approach recognizes that matter remains constant in a closed system, implying that waste generated equals resources depleted. While industrial ecology promotes material symbiosis and resource minimization to reduce the use of virgin materials and environmental sinks, economic analysis suggests there is a cut-off point where the burdens of recycling may exceed the net benefits.

The four economic functions of the environment serve as the analytical foundation for understanding human welfare in relation to nature. These functions include providing amenity values, such as the direct pleasure derived from landscapes or the existence of species; acting as a resource base for both renewable and non-renewable inputs; serving as a sink for the residuals of economic activity; and functioning as a fundamental life-support system. A circular economy seeks to manage these functions by acknowledging that discharging residuals beyond the environment’s assimilative capacity causes harm and represents a loss to the economic system.

Sustainable development and sustainable economic welfare require managing natural capital so that future generations are secured a level of welfare equal to the present. This necessitates maintaining a constant stock of environmental resources or, in the case of weak sustainability, compensating for the depletion of natural capital by investing in human or physical capital. Hartwick’s savings rule specifically suggests that rents from natural resource extraction, such as fossil fuels, should be reinvested into other capital types to ensure a sustainable stream of future income.

External effects occur when economic transactions between two parties result in unintended positive or negative consequences for a third party. Negative environmental externalities arise when economic activities impact amenity values, lead to resource depletion, or exceed the assimilative capacity of biological systems. Identifying the optimal level of environmental control requires quantifying these effects and valuing environmental goods, often through life cycle assessments or by revealing individual preferences.

Market prices reflecting external costs allow for the internalization of environmental impacts through taxes and charges. This approach improves allocative efficiency by ensuring prices reveal the true social cost of commodities, encouraging producers to use fewer environmental resources. Furthermore, externality taxation provides a continuous incentive for developing cleaner technologies and offers companies the flexibility to find individual cost-effective solutions.

Techniques for accounting for external costs have advanced through the impact pathway approach, which traces pollutants from their source to their ultimate economic value. This methodology involves four steps: calculating marginal changes in pollutant concentrations, determining the number of people and assets exposed using geographical information systems, applying dose-response functions to quantify physical impacts, and attaching monetary unit values to those impacts. Such analysis captures site-specific factors, such as population density and existing abatement technologies, to reach more accurate externality estimates.

A socio-economic analysis of the circular economy evaluates projects by matching their total costs against benefits derived from the market value of recycled materials, the reduced burden of waste disposal, and the decreased extraction of virgin materials. When authorities institute taxes on key pollutants or require detailed economic analysis, activities that diminish the net environmental burden become profitable for companies. While current monetary estimates provide an incomplete picture, they serve as a necessary tool for shifting the economy toward a sustainable future trajectory.

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