By Kimberly Burnett, James Roumasset, and Christopher Wada

The Circular Economy

In 1969, Belgian industrial designers Paul Jorion and Jacques Braijt proposed the circular concept of manufacturing products from recycled materials as opposed to the “linear” concept of producing them from mined or harvested raw materials and discarding the corresponding waste (short history here). The idea has gained more traction recently, both in the United States and beyond, as a framework with the potential to address a number of global issues ranging from biodiversity loss to climate change. There are over 100 definitions of “circular economy” currently in circulation, and most seem to strongly emphasize the need to decouple economic growth or activity from the use or consumption of natural resources. Utopian proponents of the circular economy argue that this can be achieved by following three general principles: (1) eliminating waste and pollution, (2) circulating products and materials through processes like reuse, refurbishment, remanufacturing, and recycling, and (3) regenerating nature. Sustaining current or growing levels of living may not be possible by completely eliminating waste and pollution however. At a more operational level, some (circular) economists recommend that society’s rate of resource extraction remain below the rate of resource consumption, and the rate of waste production remain below the environment’s ability to absorb and transform the waste. As noted in the description to an upcoming UH Innovation Conference on “Advancing a Circular Economy in Hawai‘i,” some supporters further motivate the approach by juxtaposing it with the linear “take, make, use, waste” economy. We argue that standard ecological resource economics already has the tools required to analyze many of the same issues and is not incompatible with most circular economy goals.

The Environomy Framework

It is useful to start with the concept of the environomy, which embeds the standard circular flow diagram from economics into a representation of nature. Nature generates amenities directly valued by households but also provides resource inputs for production of goods and services by firms in the economy. Production can generate spillover effects such as pollution, and the depletion of natural resources can also have direct unintended consequences for the environment, such as reduction in natural habitat and subsequently biodiversity loss (Figure 1). Given the many linkages within the environomy system, completely decoupling economic activity from consumption of natural resources seems rather challenging if not impossible, and furthermore unnecessary. However, this is not to say that economic activity in Hawai‘i and elsewhere is “socially efficient”, i.e., welfare-maximizing for society. In fact, mainstream economics does not say that markets are always or even usually efficient. Rather, it recognizes that markets may produce too much pollution and waste and then offers multiple ways for correcting the operation of markets so that they limit pollution to an efficient level. This field, started almost 90 years ago by A.C. Pigou, has blossomed into the discipline of environmental economics.

Figure 1. The Environomy

Environmental Economics and Beyond

You likely have heard of a carbon tax but may be unfamiliar with a Pigouvian tax. As it turns out, carbon taxes are subspecies of Pigouvian taxes. So what exactly is a Pigouvian tax? Just as you would pay for damages you did to someone’s car (typically via insurance), a Pigouvian tax charges polluters for the damages done to society’s welfare. For example, if a firm’s production process generates air pollution, then imposing a Pigouvian tax increases the cost to the firm, which incentivizes it toward reducing pollution to (economically) efficient levels.1 But what about the case where depletion of the natural resource itself (rather than the production process) generates a negative externality? Fortunately, the paradigm of market correction has been extended to natural resource depletion as described and modeled in ecological resource economics. When all of the linkages in the environomy are adequately accounted for, implementing the efficiency prices implicit in an ecological resource economics model will encourage welfare-maximizing behavior in line with desired outcomes from a circular economy model. This approach also suggests that payments for ecosystem services be made for watershed and other landscapes that increase groundwater recharge and decrease soil erosion and fire risk. This aligns with the third circular economy principle of regenerating nature. 

By formalizing sustainable development based on the concept of the environomy, one can derive the amounts of resource depletion and environmental degradation that are compatible with optimal and sustainable economic growth, instead of imposing artificial thresholds. The corresponding theory also provides the basis for sustainable income accounting, even including shocks to the economy such as those imposed by natural disasters. The following real world examples may help to illuminate these concepts.

Mountain-to-Sea Ecological Resource Economics in Hawai‘i

Linkages from “mountain to sea” or “ridge to reef” have been increasingly recognized as key components of integrated coastal management, particularly in island regions such as Hawai‘i. Though quantifying those linkages is challenging under often data-limited conditions, viewing the management challenge through an ecological resource economics lens illustrates how this approach can achieve economic efficiency without undermining the three general principles of the circular economy. Most of the drinking water in the state comes from groundwater aquifers–basically freshwater below the ground surface. These aquifers are recharged by precipitation over time, and the amount that actually infiltrates into the ground depends, in part, on the overlying land cover. Whatever is not pumped out of the ground for consumption flows toward the shoreline, where some of it eventually discharges into the nearshore area as springs or submarine groundwater discharge (SGD). Groundwater dependent ecosystems (GDE) will thrive only if SGD is maintained at a certain level. When all of the pieces are considered in aggregate, it should be clear that any upstream actions will have (intended or unintended) consequences on the downstream components of the system. Therefore, optimal management should account for the effects of various externalities simultaneously.

In this particular example, we don’t include water pollution, but the link between groundwater pumping, SGD, and ultimately GDEs can illustrate the same point. If we value the GDE, which may include culturally, ecologically and/or economically important fish and limu, then unintended damages due to upstream activities can be viewed as a negative externality. Analogous to the pollution case, if the value of the GDE is properly accounted for, the optimal rate of groundwater pumping for consumption will be lower than it otherwise would be, and this can be achieved through higher water rates for upstream users. At the same time, upstream land managers have the opportunity to support increased regeneration of the groundwater resource if the proper incentives are in place. A payments for ecosystem services program can support land uses (e.g., thoughtfully designed agroforestry systems) that enhance the watershed’s recharge capability. Lastly, wastewater recycling and desalination can be integrated into the comprehensive water management plan as it becomes economically optimal to do so. The Honolulu Board of Water Supply already uses recycled wastewater for non-potable purposes to some extent, and this share will likely increase over time as technology improves and gets cheaper, and as freshwater gets scarcer. At these smaller scales, most of the elements of the circular economy can be handled by ecological resource economics models. Theoretically ecological resource economics should be able to handle any scale, though modeling will be limited by available data and understanding of linkages between and among social and natural systems and implementation challenging due to political considerations, status quo institutional arrangements, and other obstacles associated with transformational change. 

Acknowledgements: Special thanks to Sumner La Croix for inspiring this blog, and for his helpful comments and suggestions.


  1. Economics 101 says that the marginal private benefit (MPB) of consuming a good decreases with the quantity demanded, while the marginal private cost (MPC) of supplying that good increases with the quantity supplied. An efficient market clears (reaches an equilibrium) when MPB=MPC, i.e. at the intersection of the usual downward sloping demand curve and upward sloping supply curve. However, if the firm producing the good is generating pollution (a negative externality), the marginal external cost (MEC) should be added to the MPC to determine the marginal social cost (MSC). In this case, the socially optimal equilibrium occurs where MPB=MSC, and we can incentivize the firm to adjust their production to this lower quantity by taxing them at a rate equal to the MEC at the social optimum. ↩︎

2 thoughts on “Ecological Economics and the Circular Economy”

  1. Ecological resource economics embeds the standard circular flow diagram within nature, thereby accounting for the natural resources taken out of nature and the waste products put back in. These relationships allow the economist to solve for the amount of resource extraction, regeneration, recycling, waste treatment etc. that best promote the general welfare without recourse to ad hoc rules of thumb (such as zero pollution) that tend to undermine sustainable growth.

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