Wed, Feb 24, 2021
by Marjo Koivisto and Daria Taglioni
Aside from accelerating decarbonization of industries, a key priority in the global economy today is to reduce the use of virgin materials. In discussions over the circular economy (CE), emphasis is usually put on “reusing” and “recycling”. Instead, for CE to grow sufficiently to avert the grim projections of the global economy running out of materials within decades, more pervasive change is needed. The notion that products and materials that depreciate slower are more valuable must be better internalized by their industrial and household consumers. Additionally, in place of launching new physical products to drive value, companies should monetize more the value of after-sale services for products and software updates – both to reduce material flow, and to retain and grow the lifetime value of customers.
Critically, developing countries must not be excluded from the transition to CE, if material demand is to be successfully kept within the earth’s limits. CE needs to target the sources of demand growth, namely the developing world. Half of the world’s 7,6 billion people need more food and clothes to advance their standards of living, which means more physical goods need to be produced. Can this demand be met with circular economic models? Can global shift to CE also create jobs in the developing world?
Everledger, a technology company operating across Africa using blockchain, has become an essential service provider of traceability services for product quality verification to the global mining sector. HS Timber Group creates value in the timber industry by making traceability core to its business. Virogreen in Singapore and R&R in Bangladesh repurpose waste and electronics to serve new clients across industries. What do all these companies have in common? They fundamentally redesigned the business model in their respective industries, with the objective or indirect consequence of producing with less virgin materials and resources.
“Redesigning” products, business models, and innovating to finance them is key to achieve CE. Only in this way CE products and approaches can become economically viable and competitive.
Figure 1. The sequence of goals in the CE transition
The transition needs few main ingredients: fast deployment of technology, experimentation with business models, products, and processes, and tailored financing and regulation.
Fortunately, much of the technology is already available. General purpose technologies operated on increasingly powerful and globally available mobile telecom connectivity networks enable to lengthen products product lifecycle. Feature updates via software reduce the rate at which new versions of the physical product are needed; IoT enables traceability, tracking, and repairs. As for green technologies, many already exist that create economic efficiencies by repurposing materials. This is the case, for example, for machinery and software that maximizes the recovery of commodities and raw materials from electronic waste without data security risks. However, not all green technologies are mature yet. Some, such as nanotechnologies allowing de-materialization and self-healing of products, need lower unit costs and greater availability to flourish.
Investors need to propose innovative financing solutions. Applying innovative materials can have high upfront costs. Meanwhile, for the many asset-light circular business models that use mature technologies, investors need a better understanding of their risk-return profile.
Figure 2. Conceptual framework for transitioning to a CE model
Financing large CE capital projects, which involve relatively immature technology, requires creativity. The long-term exposure needed is excessive for most commercial financiers and borrowing from commercial banks is often not an option. Both Solvency II and Basel III favor shorter tenor loans for projects. Instead creative capital structures that allow the matching of different risk-appetites and to mitigate risks, can support the realization of CE projects.
Asset light CE businesses, such as in asset-sharing transport, have their peculiar financing needs. Beyond financing needs for scaling-up, CE businesses need more working capital, for example for handling the lease on their products circulating in the market. With many CE businesses pivoting towards the “product as a service” sale model, being able to use contracts and receivables as one form of financing ‘collateral’ would allow to leverage their usually strong customer relationships.
Global brands can accelerate the transition to CE, too. First, brands are responsible for designing new products, processes and business models. Second, strong of supplier networks that often include hundreds of companies, they can accelerate technology adoption and efforts to reduce, reuse, and recycle. They can both push suppliers to produce in the new way and they can pull them by demanding CE-compliant practices.
A lopsided transition excluding the developing world might make things worse. A divergence in regulations may create incentives for resource-inefficient productions to relocate to jurisdictions with more lenient regulations. Transition to CE business models in the developed world also means less demand for commodities from developing countries. Firms specialized in the commodity trade—as many developing country firms are—may see sales shrink across the board, as developed markets limit the use of virgin materials. But the fall in demand for commodities may also lead to a slump in their price large enough to make it even harder for CE business to compete with traditional commodity-based production.
Fortunately, the shift to circularity offers many opportunities to partake in innovative and dynamic industries for developing countries too, especially if new financing models take hold. Firms in developing countries, including both MNCs and suppliers, can benefit from financial innovation catering to the needs of CE businesses. They can use CE models and already widely available general purpose technologies to serve their sizable domestic or regional markets as well as global demand.
Marjo Koivisto, PhD, is an investment professional at Proventus Capital Partners, based in Stockholm, Sweden. She was previously Co-Head of Responsible Investments at Nordea Asset Management; Lead of Economics and Finance programme at the World Economic Forum in New York, and worked in World Bank transactions for EMEA. She is a Bretton Woods Committee Member.
Daria Taglioni, PhD, is Research Manager, Trade and International Integration, Development Research Group. She was previously the principal economist at the IFC, WBG’s global lead on Global Value Chains, and senior economist at the ECB, the OECD. She is based out of Washington, D.C.