Global outlook not great

I was at a conference on secondary commodity markets on Tuesday at which Ross Strachan from Capital Economics gave quite an interesting overview of their outlook for the global economy.

Essentially, things aren't looking particularly bright in their view. Europe is heading towards disaster and the ultimate break-up of the Euro, while China is slowing down too. There are some slightly better signs from the US (if policy makers there are able to agree a budget deal) but overall, it looks to them as though the global economy is at best heading sideways for a good while to come.

I tend to agree with their outlook (although I am not yet convinced that the Euro will break up). I would also add that forthcoming banking regulations are going to be an additional constraint on growth by restricting new investment.

What does this mean for the waste sector? Operators are already suffering extremely tough times, with waste volumes and recyclate prices down on previous highs. A faltering macroeconomic recovery will continue to squeeze the sector at both ends with operators potentially suffering lower gate fees at the front end as they chase lower volumes and lower offtake revenues for materials at the back.

In the medium term there may be some respite for integrated businesses as increasing moves into the waste-to-energy space coincide with policy designed to drive up energy prices, thereby helping to support offtake revenues in that area.

But in the meantime, its likely to remain tough going. MRF gate fees tend to be sticky relative to prices of secondary commodities and if some recyclers haven't properly managed their recyclate price risk then they could find themselves struggling in the near term.

Policy wonks vs operators

The big annual waste shindig has been taking place at the NEC for the past couple of days. I intend to post  on some of the conference later, but my first initial observation is that there seems to be a growing divergence  in views expressed by policy wonks and those by waste operators facing reality on the ground.

In particular, via @Greendipped I see that Gavin Shuker expressed ongoing concerns about scarcity (something regular readers would know I don't see as a problem), while at the same time Steve Lee gave a presentation on the first day titled "understanding the potential impact of resource scarcity and escalating commodity prices".

I have pointed out before that in reality (non-food) commodity prices are falling, and it was concern about these falling prices that was the main message to come from waste operators at the conference (see also e.g. this story). It is these operators who are facing the actual conditions at the coal face and I would certainly trust their experience more than the hypotheticals coming from others with less direct day to day experience of reality.

The waste industry is going through a very difficult period of transition. Waste volumes are down and recycling prices are falling. Policy and regulation are designed to drive the waste industry away from the traditional stable landfill based model with low capital outlay towards high up-front capital investment and large exposure to cyclical global commodity markets. Managing this transition will be difficult and there will likely be some who don't do it well.

As long as policy makers don't understand the reality of cyclical markets they are unlikely to be able to come up with a policy framework that will help the industry navigate its way in the world.

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.

FOE demands more on resource efficiency

The EEF, Friends of the Earth, and others, have published the paper behind yesterday's call for government to do more on resource efficiency, in which they make a list of various recommendations.

Overall, this paper feels to me a bit like they are fighting the last war. We have been through the biggest commodity boom in history and the global economy is now slowing. Resource prices are falling and, as they note themselves, Asian demand for materials is weakening. Known supplies and production of commodities are at all time highs and weakening prices should help domestic manufacturers whose lack of competitiveness means they struggle to pay the same prices for recyclates as overseas competitors.

The EEF really should know better on this score as they recently surveyed their members and found that three quarters of them had either implemented or were about to implement resource efficiency measures. They call for more incentives, but yet fail to note that the resource productivity of the UK economy has increased eighteen fold in the last 30 years and its total material requirement has been in decline since 2001.

They propose to extend the scope of the government's Resource Security Action Plan as it is currently too narrowly focused on resources which are currently in demand. This though highlights one of the key problems with central planning of a complex economy. We have no idea what the resource requirements of the future will be and so cannot plan for their security. The best way we know to allocate resources in an economy is through open markets and the price mechanism. Focusing on global trade and keeping international markets open is the best thing that government could do to help ensure as diverse a supply of resources as possible, and therefore the security of those resources.

There is also the ongoing call for improved quality of UK recyclate. But the key issue for me in this debate is domestic manufacturers' lack of competitiveness, which means they are unable to match the prices paid by overseas reprocessors for material of equivalent quality. It would be nonsensical for domestic collectors to accept a lower price for their material.

If overseas demand does indeed weaken as predicted in the paper, then domestic manufacturers will be in a strong position and there is no need for intervention in the market. At the end of the day, markets are already driving up quality standards. What needs to be considered is who will pay for that quality. It will either be the reprocessor in the form of higher recyclate prices or it will be the waste producer in the form of higher gate fees at MRFs.

There are some good proposals in the paper, such as looking at improving data and re-examining the PRN//PERN distinction (so long as this is not merely a ploy to place additional burdens on exporters). But there are wrong-headed ones too, such as restricting materials from energy from waste plants, which would merely serve to kill off investment in much needed residual waste infrastructure.

Overall though, there are too many calls for government intervention. Global commodity/resource markets are the best methods we have for allocating resources and should be allowed to continue to do their job.

New calls for government to improve resource efficiency

EEF and Friends of the Earth are calling for a new Office for Resource Management in government to co-ordinate the UK's resource strategy (via @James_BG).

I have no idea what such an office would be expected to do. Commodity prices are set by global markets. Businesses have an in-built commercial imperative to respond to these prices. The EEF's own survey recently told us that 75% of UK manufacturing businesses have already implemented resource efficiency measures or are in the process of doing so. Why do we need a new Government department to tell these businesses what they need to do?

Their submission includes the increasingly common reference to a decade of price rises wiping out a century of declines. But as I have previously argued here, the relative prices of commodities are in fact still low in historic terms. I can buy a (two and half times) bigger basket of commodities with my labour now than I would have been able to 30 years ago.

The timing of this call to arms is also strange to me. The EEF is quoted as saying 'prices are on an upward trend'. This is not in fact based in reality where prices are down in the past year.

Of course there is yet another call to ban recyclable material being sent to landfill. In my mind, the landfill tax escalator is already driving recyclable material out of landfill. If there really is going to be a resource crunch and prices really are going to rise then there will be no need for a ban as simple economics will lead to this material being recycled.

London debates the environmental imperative

Matt Ridley, the rational optimist, was the keynote speaker at yesterday's London debate on the environmental imperative. It was generally an interesting discussion, and in contrast to the vast majority of policy 'debates' actually contained some divergent views. I have become thoroughly bored with the type of occasion where six panellists all stand up one after the other and agree on absolutely every point.

There was of course disagreement from many in the audience about Ridley's sunny prognosis for the state of the planet and several people accused him of cherry picking his statistics, but I don't recall anyone actually being able to catch him out on a specific point.

I was surprised however by the general level of agreement with some of Ridley's views. In particular, there seemed to be recognition that innovation and new technology will likely be required to offset growing environmental pressures, and that economic growth will be required to generate the capital to fund these new technologies.

When it came to resources, Ridley made the point I would agree with that scarcity is not an issue. I was then disappointed that Ben Goldsmith, billed as an expert in green finance, chose to raise the issue of recent resource price rises and how these have wiped out a century of declines (previously argued by McKinsey in the circular economy report for the Dame Ellen MacArthur Foundation). I of course think that the real issue is the relative price of resources which are still at historically low levels. Commodity markets are in any case cyclical and prices will likely come down again.

Stuff is cheap and will continue to be cheap for a long wile yet.

How to deliver a circular economy

The Dame Ellen MacArthur Foundation is leading the charge on how to move the economy from a linear to a circular model. They cite case studies to demonstrate how a more circular approach can be a reality for businesses now and suggest that price signals alone may not be sufficient to deliver a transition to the new approach.

The underpinning rationale for why we need a circular economy is, of course, the old environmentalists' fallacy about resource scarcity: the classic fear that we are going to run out of stuff. But, as I have argued before, we have more stuff now than at any time in history, despite increasing pressures.

How can this be so? The stuff of nightmares never materialises because people consistently underestimate the capacity of technological progress, coupled with the price mechanism, to increase the supply of recoverable resources. Scarcity just isn't an issue.

That doesn't necessarily mean that a movement towards a circular economy would be a bad thing. If cost savings and environmental benefits can be found then it could still be the right thing to do.

I am personally unconvinced by the large unrealised savings which the report estimates could result from a shift to a circular economy. I haven't gone through the analysis in detail but suspect that they fail properly to account for the opportunity costs involved in implementing resource efficiency/circular economy measures (as previously argued here). Let us assume however that there are large benefits to be found. Moving to a circular economy would be a good thing to do.

So how best could we get there? The answer, as you would expect from an economist, is markets. Markets allocate resources more efficiently than central planners. The EMF worries that prices won't respond quickly enough to effect the transition which they think is necessary. But you can rest assured that markets and prices will do a better job than policy makers and bureaucrats.

The existence of the EMF's case studies for me show that we don't need intervention. On the contrary, where there are opportunties to make a profit from the circular economy then economic actors step in and exploit them. The report claims that the concept is economically viable and scalable. In that case, I reckon that the authors should go out and make a pile from actually doing a circular economy, rather than talking about it.

WRAP calls for longer lived clothes

WRAP has published new research into the environmental impacts of clothing and expressed concerns that people are purchasing too many items which are too short lived. They lament the fact that people's wardrobes contain garments which haven't been worn for at least a year and suggest that people should try to extend the lives of their clothing.

Their research tells them that consumers would be willing to explore new options for repair, buying pre-owned clothes, and other ways of extending their clothing lives. This same research though tells them that the main reason people stop wearing clothes is that they no longer fit. Presumably WRAP believes that these clothes should be altered, rather than replacements purchased.

This however runs into the modern resource conundrum: while resources are supposedly running out and are apparently incredibly expensive/valuable, in reality their relative prices are low (despite the biggest commodity boom in history), particularly when compared to labour. Clothes are cheap and so the average person can afford plenty of them.

WRAP estimates that the global carbon footprint of UK clothing consumption is 1.5 tonnes per household per year. Even if we make consumers pay these carbon costs, that would only amount to around £45/household/year (using government assumptions). This is around 2.5% of what WRAP suggests UK households spend on clothing. Not enough in my view to make much of a difference to consumption patterns, even if fully internalised.

WRAP seems to think that if consumers are given better information about the environmental footprint of their clothing, their consumption patterns could change. I am not convinced. WRAP's research may indicate that people aren't interested in fashion and updating their wardrobes constantly, but consumers' revealed preferences - from their actual consumption behaviour - tell us a different story.

It is likely that the costs of clothing as a proportion of consumer expenditure will remain small over time, which in turn means that we are unlikely to see a dramatic reduction in consumption. Unless WRAP advocates punitive taxes on clothes or wardrobe rationing, I think this is unlikely to change much and WRAP's focus should instead be on production processes (which to be fair are also examined in the report).

Monbiot gets resource economics?

George Monbiot has an interesting piece in the Guardian today: http://www.guardian.co.uk/commentisfree/2012/jul/02/peak-oil-we-we-wrong.

In it he seems to recognise one of the basic principles of resource economics: higher prices stimulate higher supplies. Unlike him, I don't see this necessarily as an issue of grave concern.

What is true for peak oil is also true for other commodities. Resource scarcity isn't a problem for today's society.

APSRG debate: the waste sector and the green economy

The Associate Parliamentary Sustainable Resource Group (APSRG) held a debate in Portcullis House on Wednesday on the role of the waste sector in the green economy.


There was the usual mix of unsubstantiated assertion about resource scarcity and the imperative of changing our profligate ways, interspersed with some genuinely interesting examples of resource efficiency in practice. One of the main messages from the panel seemed to be that higher resource prices were changing business models. The waste sector is already being driven by recyclate markets/prices and as these increase over time we will see this effect rise higher up the hierarchy into the delivery of goods as services

I just can't help thinking though that it isn't economics that will determine the waste sector's role in the green economy in the medium term but legislation. We have just been through the biggest commodity boom in history (notwithstanding the fact that the relative prices of resources are still low by historic standards), and although this has undoubtedly driven some resource efficiency measures throughout the economy, it is the landfill tax escalator which has actually delivered the large increases in domestic recycling rates over the past decade.

Economic fundamentals are likely to continue to lead to lower resource costs relative to labour costs throughout the global economy. Resource prices on their own are never likely to drive the sorts of fundamental shift in consumption and production patterns which environmental policy protagonists think will be necessary.

Instead, a more interesting question for the long term might be whether global factor price equalisation will lead to the future repatriation of more manufacturing activity. If so, then we may in the future find that domestic industry is able to provide output destinations for the recyclate which currently has to be exported overseas.

I find this a more likely route to a circular economy than the more commonly presented alternative, but it is one which is likely to be quite a few decades away, which no doubt is not the sort of pace of change felt necessary in environmental circles.