Circular economy
A circular economy is a regenerative system in which resource input and waste, emission, and energy leakage are minimised by slowing, closing, and narrowing material and energy loops. This can be achieved through long-lasting design, maintenance, repair, reuse, remanufacturing, refurbishing, and recycling. This is in contrast to a linear economy which is a 'take, make, dispose' model of production .
Scope
The term encompasses more than the production and consumption of goods and services, including a shift from fossil fuels to the use of renewable energy, and the role of diversity as a characteristic of resilient and productive systems. It includes discussion of the role of money and finance as part of the wider debate, and some of its pioneers have called for a revamp of economic performance measurement tools.Origins
"The concept of a circular economy (CE) has been first raised by two British environmental economists David W. Pearce and R. Kerry Turner in 1989. In Economics of Natural Resources and the Environment, they pointed out that a traditional open-ended economy was developed with no built-in tendency to recycle, which was reflected by treating the environment as a waste reservoir".The circular economy is grounded in the study of feedback-rich (non-linear) systems, particularly living systems. A major outcome of this is the notion of optimising systems rather than components, or the notion of ‘design for fit’. As a generic notion it draws from a number of more specific approaches including cradle to cradle, biomimicry, industrial ecology, and the 'blue economy’.Moving away from the linear model
Linear "take, make, dispose" industrial processes and the lifestyles that feed on them deplete finite reserves to create products that end up in landfills or in incinerators.This realisation triggered the thought process of a few scientists and thinkers, including Walter R. Stahel, an architect, economist, and a founding father of industrial sustainability. Credited with having coined the expression "Cradle to Cradle" (in contrast with "Cradle to Grave", illustrating our "Resource to Waste" way of functioning), in the late 1970s, Stahel worked on developing a "closed loop" approach to production processes, co-founding the Product-Life Institute in Geneva more than 25 years ago. In the UK, Steve D. Parker researched waste as a resource in the UK agricultural sector in 1982, developing novel closed loop production systems mimicking, and integrated with, the symbiotic biological ecosystems they exploited.
Emergence of the idea
In their 1976 Hannah Reekman research report to the European Commission, "The Potential for Substituting Manpower for Energy", Walter Stahel and Genevieve Reday sketched the vision of an economy in loops (or circular economy) and its impact on job creation, economic competitiveness, resource savings, and waste prevention. The report was published in 1982 as the book Jobs for Tomorrow: The Potential for Substituting Manpower for Energy.Considered as one of the first pragmatic and credible sustainability think tanks, the main goals of Stahel's institute are product-life extension, long-life goods, reconditioning activities, and waste prevention. It also insists on the importance of selling services rather than products, an idea referred to as the "functional service economy" and sometimes put under the wider notion of "performance economy" which also advocates "more localisation of economic activity".
In broader terms, the circular approach is a framework that takes insights from living systems. It considers that our systems should work like organisms, processing nutrients that can be fed back into the cycle—whether biological or technical—hence the "closed loop" or "regenerative" terms usually associated with it.
The generic Circular Economy label can be applied to, and claimed by, several different schools of thought, that all gravitate around the same basic principles which they have refined in different ways. The idea itself, which is centred on taking insights from living systems, is hardly a new one and hence cannot be traced back to one precise date or author, yet its practical applications to modern economic systems and industrial processes have gained momentum since the late 1970s, giving birth to four prominent movements, detailed below. The idea of circular material flows as a model for the economy was presented in 1966 by Kenneth E. Boulding in his paper, The Economics of the Coming Spaceship Earth. Promoting a circular economy was identified as national policy in China’s 11th five-year plan starting in 2006. The Ellen MacArthur Foundation, an independent charity established in 2010, has more recently outlined the economic opportunity of a circular economy. As part of its educational mission, the Foundation has worked to bring together complementary schools of thought and create a coherent framework, thus giving the concept a wide exposure and appeal.
Most frequently described as a framework for thinking, its supporters claim it is a coherent model that has value as part of a response to the end of the era of cheap oil and materials and can contribute to the transition to a low carbon economy. In line with this, a circular economy can contribute to meet the COP 21 Paris Agreement. The emissions reduction commitments made by 195 countries at the COP 21 Paris Agreement, are not sufficient to limit global warming to 1.5 °C. To reach the 1.5 °C ambition it is estimated that additional emissions reductions of 15 billion tonnes CO2 per year need to be achieved by 2030. Circle Economy and Ecofys estimated that circular economy strategies may deliver emissions reductions that could basically bridge the gap by half.
Sustainability
The circular economy seems intuitively to be more sustainable than the current linear economic system. The reduction of resource inputs into and waste and emission leakage out of the system reduces resource depletion and environmental pollution. However, these simple assumptions are not sufficient to deal with the involved systemic complexity and disregards potential trade-offs. For example, the social dimension of sustainability seems to be only marginally addressed in many publications on the Circular Economy, and there are cases that require different or additional strategies, like purchasing new, more energy efficient equipment. By reviewing the literature, a team of researchers from Cambridge and TU Delft could show that there are at least eight different relationship types between sustainability and the circular economy:[1]1. Conditional relation
2. Strong conditional relation
3. Necessary but not sufficient conditional relation
4. Beneficial relationship
5. Subset relation (structured and unstructured)
6. Degree relation
7. Cost-benefit/trade-off relation
8. Selective relation
Key elements
With a surge in popularity, many circular principles are available, varying widely depending on the problems being addressed, the audience, or the lens through which the author views the world. There are at least the following key elements to be identified within a circular economy.Prioritise regenerative resources
Ensure renewable, reusable, non-toxic resources are utilised as materials and energy in an efficient way. Ultimately the system should aim to run on ‘current sunshine’ and generate energy through renewable sources. An example of this principle is The Biosphere Rules framework for closed-loop production which identifies Power Autonomy as one of nature's principles for sustainable manufacturing. It requires that energy efficiency be first maximized so that renewable energy becomes economical. It also requires that materials need to be non-toxic to be able to recirculate without causing harm to the living environment.Use waste as a resource
The second element aims to utilise waste streams as a source of secondary resources and recover waste for reuse and recycling and is grounded on the idea that waste does not exist. It is necessary here to design out waste, meaning that both the biological and technical components (nutrients) of a product are designed intentionally in such a way that waste streams are minimalized.Design for the future
Account for the systems perspective during the design process, to use the right materials, to design for appropriate lifetime and to design for extended future use. Meaning that a product is designed to fit within a materials cycle, can easily be dissembled and can easily be used with a different purpose. Hereby one could consider strategies like emotionally durable design. It should be stressed that there is not something like one ideal blueprint for future design. Modularity, versatility and adaptiveness are to be prioritised in an uncertain and fast evolving world, meaning that diverse products, materials, and systems, with many connections and scales are more resilient in the face of external shocks, than monotone systems built simply for efficiency.Preserve and extend what’s already made
While resources are in-use, maintain, repair and upgrade them to maximise their lifetime and give them a second life through take back strategies when applicable. This could mean that a product is accompanied with a pre-thought maintenance programme to maximise its lifetime, including a buyback program and supporting logistics system. Second hand sales or refurbish programs also falls within this element.Collaborate to create joint value
Within a circular economy, one should work together throughout the supply chain, internally within organisations and with the public sector to increase transparency and create joint value. For the business sector this calls for collaboration within the supply chain and cross-sectoral, recognising the interdependence between the different market players. Governments can support this by creating the right incentives, for example via common standards within a regulatory framework and provide business support.Incorporate digital technology
Track and optimise resource use and strengthen connections between supply chain actors through digital, online platforms and technologies that provide insights. It also encompasses virtualized value creation and delivering, for example via 3D printers, and communicating with customers virtually.Prices or other feedback mechanisms should reflect real costs
In a circular economy, prices act as messages, and therefore need to reflect full costs in order to be effective. The full costs of negative externalities are revealed and taken into account, and perverse subsidies are removed. A lack of transparency on externalities acts as a barrier to the transition to a circular economy.The circular economy framework
The circular economy is a highly contested framework, as evidenced by a recent review of 114 circular economy understandings . Nevertheless, several core principles can be identified across the different frameworks. These are depicted below.Systems thinking
The ability to understand how things influence one another within a whole. Elements are considered as ‘fitting in’ their infrastructure, environment and social context. Whilst a machine is also a system, systems thinking usually refers to nonlinear systems: systems where through feedback and imprecise starting conditions the outcome is not necessarily proportional to the input and where evolution of the system is possible: the system can display emergent properties. Examples of these systems are all living systems and any open system such as meteorological systems or ocean currents, even the orbits of the planets have nonlinear characteristics.Understanding a system is crucial when trying to decide and plan (corrections) in a system. Missing or misinterpreting the trends, flows, functions of, and human influences on, our socio-ecological systems can result in disastrous results. In order to prevent errors in planning or design an understanding of the system should be applied to the whole and to the details of the plan or design. The Natural Step created a set of systems conditions (or sustainability principles) that can be applied when designing for (parts of) a circular economy to ensure alignment with functions of the socio-ecological system.
The concept of the circular economy has previously been expressed as the circulation of money versus goods, services, access rights, valuable documents, etc., in macroeconomics. This situation has been illustrated in many diagrams for money and goods circulation associated with social systems. As a system, various agencies or entities are connected by paths through which the various goods etc., pass in exchange for money. However, this situation is different from the circular economy described above, where the flow is unilinear - in only one direction, that is, until the recycled goods again are spread over the world.
Biomimicry
Janine Benyus, author of "Biomimicry: Innovation Inspired by Nature", defines her approach as "a new discipline that studies nature's best ideas and then imitates these designs and processes to solve human problems. Studying a leaf to invent a better solar cell is an example. I think of it as "innovation inspired by nature. Biomimicry relies on three key principles:- Nature as model: Biomimicry studies nature’s models and emulates these forms, processes, systems, and strategies to solve human problems.
- Nature as measure: Biomimicry uses an ecological standard to judge the sustainability of our innovations.
- Nature as mentor: Biomimicry is a way of viewing and valuing nature. It introduces an era based not on what we can extract from the natural world, but what we can learn from it.
Industrial ecology
Industrial Ecology is the study of material and energy flows through industrial systems. Focusing on connections between operators within the "industrial ecosystem", this approach aims at creating closed loop processes in which waste is seen as input, thus eliminating the notion of undesirable by-product. Industrial ecology adopts a systemic - or holistic - point of view, designing production processes according to local ecological constraints whilst looking at their global impact from the outset, and attempting to shape them so they perform as close to living systems as possible. This framework is sometimes referred to as the "science of sustainability", given its interdisciplinary nature, and its principles can also be applied in the services sector. With an emphasis on natural capital restoration, Industrial Ecology also focuses on social wellbeing.Cradle to cradle
Created by Walter R. Stahel, a Swiss architect who graduated from the Swiss Federal Institute of Technology Zürich in 1971. He has been influential in developing the field of sustainability by advocating philosophies of 'service-life extension of goods - reuse, repair, remanufacture, upgrade technologically' as they apply to industrialised economies. He co-founded the Product Life Institute in Geneva, Switzerland, a consultancy devoted to developing sustainable strategies and policies, after receiving recognition for his prize winning paper 'The Product Life Factor' in 1982. His ideas and those of similar theorists led to what is now known as the circular economy, in which industry adopts the reuse and service-life extension of goods as a strategy of waste prevention, regional job creation, and resource efficiency in order to decouple wealth from resource consumption, in other words, to dematerialise the industrial economy.Cooper (2005) proposed a theoretical model that illustrates the significance of product life spans in progressing towards sustainable consumption. According to the model, longer product life spans can contribute to eco-efficiency and sufficiency and thus slow consumption and help societies progress towards sustainable consumption.
Blue economy
Initiated by former Ecover CEO and Belgian entrepreneur Gunter Pauli, derived from the study of natural biological production processes the official manifesto states, "using the resources available...the waste of one product becomes the input to create a new cash flow". Based on 21 founding principles, the Blue Economy insists on solutions being determined by their local environment and physical / ecological characteristics, putting the emphasis on gravity as the primary source of energy - a point that differentiates this school of thought from the others within the Circular Economy. The report - which doubles as the movement’s manifesto - describes "100 innovations which can create 100 million jobs within the next 10 years", and provides many example of winning South-South collaborative projects, another original feature of this approach intent on promoting its hands-on focus."The Biosphere Rules"
The Biosphere Rules is a framework for implementing closed loop production processes. They derived from nature systems and translated for industrial production systems. The five principles are Materials Parsimony, Value Cycling, Power Autonomy, Sustainable Product Platforms and Function Over Form.Towards the circular economy
In January 2012, a report was released entitled Towards the Circular Economy: Economic and business rationale for an accelerated transition. The report, commissioned by the Ellen MacArthur Foundation and developed by McKinsey & Company, was the first of its kind to consider the economic and business opportunity for the transition to a restorative, circular model. Using product case studies and economy-wide analysis, the report details the potential for significant benefits across the EU. It argues that a subset of the EU manufacturing sector could realise net materials cost savings worth up to $630 billion annually towards 2025—stimulating economic activity in the areas of product development, remanufacturing and refurbishment. Towards the Circular Economy also identified the key building blocks in making the transition to a circular economy, namely in skills in circular design and production, new business models, skills in building cascades and reverse cycles, and cross-cycle/cross-sector collaboration.In January 2015 a Definitive Guide to The Circular Economy was published by Coara with the specific aim to raise awareness amongst the general population of the environmental problems already being caused by our "throwaway culture". Waste Electrical and Electronic Equipment (WEEE), in particular, is contributing to excessive use of landfill sites across the globe in which society is both discarding valuable metals but also dumping toxic compounds that are polluting the surrounding land and water supplies. Mobile devices and computer hard drives typically contain valuable metals such as silver and copper but also hazardous chemicals such as lead, mercury and cadmium. Consumers are unaware of the environmental significance of upgrading their mobile phones, for instance, on such a frequent basis but could do much to encourage manufacturers to start to move away from the wasteful, polluting linear economy towards are sustainable circular economy.
Impact in Europe
On 17 December 2012, the European Commission published a document entitled Manifesto for a Resource Efficient Europe. This manifesto clearly stated that "In a world with growing pressures on resources and the environment, the EU has no choice but to go for the transition to a resource-efficient and ultimately regenerative circular economy." Furthermore, the document highlighted the importance of "a systemic change in the use and recovery of resources in the economy" in ensuring future jobs and competitiveness, and outlined potential pathways to a circular economy, in innovation and investment, regulation, tackling harmful subsidies, increasing opportunities for new business models, and setting clear targets.The European environmental research and innovation policy aims at supporting the transition to a circular economy in Europe, defining and driving the implementation of a transformative agenda to green the economy and the society as a whole, to achieve a truly sustainable development. Research and innovation in Europe are financially supported by the programme Horizon 2020, which is also open to participation worldwide.
The European Commission introduced a Circular Economy proposal in 2015. Historically, the policy debate in Brussels mainly focused on waste management which is the second half of the cycle, and very little is said about the first half: eco-design. To draw the attention of policymakers and other stakeholders to this loophole, the Ecothis, an EU campaign was launched raising awareness about the economic and environmental consequences of not including eco-design as part of the circular economy package.
Circular business model
A circular economy calls upon opportunities to create greater value and align incentives through business models that build on the interaction between products and services. Linder and Williander describe a circular business model as “a business model in which the conceptual logic for value creation is based on utilizing the economic value retained in products after use in the production of new offerings”.Basically this means that a circular business model is not focused merely on selling a product, but encompasses a shift in thinking about value proposition, bringing forward a whole range of different business models to be used. To mention just a few examples: product-service systems, virtualized services, and collaborative consumption which encompasses the sharing economy. This comprises both the incentives and benefits offered to customers for bringing back used products and a change in revenue streams, comprising payments for a circular product or service, or payments for delivered availability, usage, or performance related to the product-based service offered.
These new ways of doing business require businesses to create an attractive business model for financiers, and financiers to change the way they perceive the risks and opportunities associated with these models. To help businesses position themselves in a circular context and develop future strategies for doing business in a circular economy, the Value Hill has been created. The Value Hill proposes a categorisation based on the lifecycle phases of a product: pre-, in- and post- use. This allows businesses to position themselves on the Value Hill and understand possible circular strategies they can implement as well as identify missing partners in their circular network. The Value Hill provides an overview of the circular partners and collaborations essential to the success of a circular value network.
Mateusz Lewandowski provides a proposition to address this need to design circular business models and presents an extension of the framework from Osterwalder and Pigneur, namely the circular business model canvas (CBMC). The CBMC consists of eleven building blocks, encompassing not only traditional components with minor modifications, but also material loops and adaptation factors. Those building blocks allow the designing of a business model according to the principles of circular economy.
XXX . V Designing the Business Models for Circular Economy—Towards the Conceptual Framework
Switching from the current linear model of economy to a circular one has recently attracted increased attention from major global companies e.g., Google, Unilever, Renault, and policymakers attending the World Economic Forum. The reasons for this are the huge financial, social and environmental benefits. However, the global shift from one model of economy to another also concerns smaller companies on a micro-level. Thus, comprehensive knowledge on designing circular business models is needed to stimulate and foster implementation of the circular economy. Existing business models for the circular economy have limited transferability and there is no comprehensive framework supporting every kind of company in designing a circular business model. This study employs a literature review to identify and classify the circular economy characteristics according to a business model structure. The investigation in the eight sub-domains of research on circular business models was used to redefine the components of the business model canvas in the context of the circular economy. Two new components—the take-back system and adoption factors—have been identified, thereby leading to the conceptualization of an extended framework for the circular business model canvas. Additionally, the triple fit challenge has been recognized as an enabler of the transition towards a circular business model. Some directions for further research have been outlined, as well.
1. Introduction
Switching from the current linear model of economy to a circular one would not only bring savings of hundreds of billions US dollars to the EU alone, but also significantly reduce the negative impact on the natural environment [1,2]. This is why the circular economy (CE) has attracted increased attention as one of the most powerful and most recent moves towards sustainability [3,4]. The transition to the circular economy entails four fundamental building blocks—materials and product design, new business models, global reverse networks, and enabling conditions [5]. Switching an economy to a circular one depends, on the one hand, on policymakers and their decisions [6]; on the other hand, it depends on introducing circularity into their business models by business entities [7]. The scope of interest of this study is limited to the latter, micro-level perspective of designing circular business models.
Comprehensive knowledge on designing circular business models is needed to stimulate and foster implementation of the circular economy on a micro-level. Existing knowledge provides several well-elaborated and verified frameworks of business models, design patterns and tools to build a business model [8,9]. Although many case studies revealed several types of circular business actions or models [4,7], these models have limited transferability. There are very few studies covering, in a more comprehensive manner, how a circular business model framework should look. Previous research instead has taken the following approaches: building on a business model canvas (BMC) and classifying the product-service system characteristics according to its structure [10]; significantly reconstructing the BMC into a business cycle canvas to support practitioners in thinking in business systems and beyond the individual business model [11]; using it as a part of a bigger framework of a business model limited to eco-innovation [12]; or extending it to encompass wider social perspectives of costs and benefits [13]. Other studies provide some steps for analyzing an existing business model for potential opportunities to introduce circularity [7,14].
None of these reviewed studies have provided satisfactory answers to the following questions: How may the principles of the circular economy be applied to a business model? What components should a circular business model consist of to be applicable to every company? This study considers the circular economy as a new contribution to the development of business model theory. Because changing a company’s business model into a circular one is challenging, the following research provides a conceptual framework of the circular business model to support practitioners in the transition process from linear business models to more circular ones.
The paper is structured as follows. Section 2 presents the concept of this study and methodological remarks. Section 3 identifies the specificity of circular business models according to the eight sub-domains of research in the area of business models proposed by Pateli and Giaglis [15]. Section 4 classifies the findings of the review according to the business model framework developed by Osterwalder and Pigneur [8]. Thus, the nine building blocks of a business model framework are characterized in the context of the circular economy. This section reveals the need to extend the business model framework to make it more applicable to the circular economy. Section 5 provides a proposition to address this need and presents a conceptualization of an extended framework of business model—the circular business model canvas (CBMC). Section 6 provides suggestions for future research. Section 7 presents the conclusions of the study.
2. The Method and Concept of the Study
In order to answer the questions how the principles of the circular economy can be applied to a business model, and which universally applicable components are needed for a circular business model, a narrative conceptual review has been employed.The process was divided into three steps.
- (1)
- Identification of the state of the art on business models in the CE (circular business models)
- (2)
- Categorization of the initial body of literature according to the components of business model structure
- (3)
- Synthesis and development of the framework for a circular business model
Figure 1. The Concept of Developing a Framework of Business Model for the Circular Economy.
2.1. Literature Review—Conceptual Frameworks for Categorizing the Research on Circular Business Models
This step identified the body of knowledge needed to obtain the answers for the research questions in the next steps. The following academic databases were used for the literature search: EBSCO Host, Google Scholar, Scopus, and ProQuest. Key words included variations on terms such as circular economy, business model, circular business model, sustainable business model. Then a complementary manual search was conducted on the websites of contributors to circular economy to look for other relevant papers, reports and books. Also the anonymous reviewers suggested some additional references.This literature search generated articles on conceptualizing the state of the art on business models in the circular economy (circular business models) according to the eight sub-domains of research in the area of business models proposed by Pateli and Giaglis [15]. Those sub-domains include: definitions, components, taxonomies, conceptual models, design methods and tools, adoption factors, evaluation models, and change methodologies [15]. The research in the sub-domain of definitions concerns defining the purpose, scope, and primary elements of a business model, as well as exploring its relationships with other business concepts, such as strategy and business processes. Thus, in relation to circular business models, a wider context of the circular economy must be explained in the first place. Research on components of business models focuses on identifying its fundamental constructs and constituent elements. They are derived from the main principles of CE. Research in the taxonomies’ sub-domain provides possible categorizations of circular business models into a number of typologies based on various criteria. Investigations related to the conceptual models focus on identifying and describing the relationship between the constituent elements of a circular business model, and include their graphical representation. Exploration of the design methods and tools concerns the development and use of methods, languages, standards and software to allow organizations to design, experiment, and change business models in an easy and cost-effective way into more circular business models. The research related to the adoption factors focuses on the factors that affect this change, as well as on socioeconomic implications of circular business models. The sub-domain related to evaluation models focuses on identifying criteria for assessing the feasibility, viability, and profitability of circular business models or evaluating them against alternative or best practice cases. Investigation concerning change methodologies pertain to guidelines, steps, and actions to be taken for transforming existing business models into a more circular one. Table 1 below presents an overview of this step, and the results are presented in the Section 2. This step identified the body of knowledge needed to obtain the answers for the research questions in the next steps.
| CBM Research Domains | Authors |
|---|---|
| Definitions | EMF Vol. 1&2 [2,4]; Joustra et al. [16]; Mentink [11]; Scott [3]; Lovins et al. [17]; Renswoude et al. [7]; Linder & Williander [18]; Ayres & Simonis [19]; Renner [20] |
| Components | EMF Vol. 1. [4]; Renswoude et al. [7]; Boons and Lüdeke-Freund [21]; Laubscher and Marinelli [22]; EMF [23]; Mentink [11]; Govindan, Soleimani, & Kannan [24] |
| Taxonomies | Lacy et al. [25]; Bakker et al. [26]; Damen [27]; EMF Vol. 1. [4]; Lacy et al. [28]; WRAP [29]; Renswoude et al. [7]; Planing [5]; Jong et al. [14]; Tukker and Tischner [30]; Van Ostaeyen et al. [31]; El-Haggar [32]; Bakker et al. [33]; Ludeke-Freund [12]; Moser and Jakl [34]; Mentink [11]; Scott [3]; Bautista-Lazo [35]; Tukker [36]; EMF [6] |
| Conceptual Models | Mentink [11]; Wirtz [9]; Osterwalder and Pigneur [8]; Barquet et al. [10]; Osterwalder et al. [37]; Ludeke-Freund [12]; Dewulf [13]; Stubbs & Cocklin [38]; Roome and Louche [39]; Gauthier and Gilomen [40]; Abdelkafi and Tauscher [41]; Jabłoński [42]; Upward and Jones [43]; Nilsson & Söderberg [44] |
| Design Methods and Tools | Joustra et al. [16]; Jong et al. [14]; Scott [3]; Renswoude et al. [7]; Osterwalder and Pigneur [8]; Mentink [11]; Barquet et al. [10]; Jabłoński [42]; Parlikad et al. [45]; El-Haggar [32]; Guinée [46] |
| Adoption Factors | Winter [47]; Planing [5]; Lacy et al. [28]; Joustra et al. [16]; Scott [3]; Parlikad et al. [45]; Mentink [11]; Laubscher and Marinelli [22]; EMF Vol. 1. [4]; Renswoude et al. [7]; Scheepens et al. [48]; EMF [6]; Jong et al. [14]; Beuren et al. [49]; Jabłoński [50]; Pearce [51]; Linder & Williander [18]; Parlikad, et al. [45]; Beuren et al. [49]; Jabłoński (2015); Zairul et al. [52]; Roos [53]; Bechtel et al. [54]; UNEP [55]; Besch [56]; Heese et al. [57]; Walsh [58]; Firnkorn & Muller [59]; Shafiee & Stec [60] |
| Evaluation Models | Winter [47]; Laubscher and Marinelli [22]; Mentink [11]; EMF [23]; Andersson & Stavileci [61]; Jasch [62]; Jasch [63]; Gale [64] |
| Change Methodologies | Scott [3]; Roome & Louche [39]; Gauthier & Gilomen [40] |
2.2. Categorization of the Initial Body of Literature According to the Components of Business Model Structure
The second step identified how the idea of circular economy can be applied to each component of the business model. This approach was inspired by Barquet et al. [10], who used a similar one for the characteristics of product-service systems (PSS). Business model structure was defined on the basis of the business model canvas (BMC) developed by Osterwalder and Pigneur [8]. BMC was chosen due to the ease of its practical application, complexity of components, worldwide recognition, and previous contributions to the development of circular business models [10,11,12]. However, a relatively large proportion of the literature pointed out several ways of applying the principles of the circular economy which exceeded the existing components of the business model. Table 2 below presents an overview of this step, and the results are presented in Section 3.
Table 2. Example categorization of the literature devoted to the circular economy according to a business model structure.
| BM components | Authors |
|---|---|
| Partners | Scott [3]; Joustra et al. [16]; El-Haggar [32]; Renswoude et al. [7]; Sheu [65]; Robinson et al. [66]; EMF Vol. 1. [4] |
| Key Activities | El-Haggar [32]; Scott [3]; WRAP [29]; Renswoude et al. [7]; Lacy et al. [28]; Rifkin [67]; Lacy et al. [25]; Joustra et al. [16]; EMF Vol. 3 [1]; Laubscher and Marinelli [22]; EMF Vol. 1. [4]; EMF [23]; EMF [6] |
| Key Resources | Planing [5]; Renswoude et al. [7]; Lacy et al. [28]; El-Haggar [32]; EMF [23]; Freyermuth [68]; Scott [3] |
| Value Proposition and Customer Segments | Jong et al. [14]; Planing [5]; Renswoude et al. [7]; Lacy et al. [28]; Parlikad et al. [45]; Bakker et al. [33]; El-Haggar [32]; Lacy et al. [25]; Scott [3]; EMF Vol. 1. [4]; Tukker and Tischner [30]; Tukker [36]; Laubscher and Marinelli [22]; Bakker et al. [26]; EMF [6] |
| Customer Relations | Renswoude et al. [7]; Recycling 2.0 [69]; Lacy et al. [25] |
| Channels | EMF [6]; Recycling 2.0 [69]; EMF [23] |
| Cost Structure | Laubscher and Marinelli [22]; Mentink [11]; Subramanian and Gunasekaran [70]; Sivertsson and Tell [71]; Berning and Venter [72]; Barquet et al. [10] |
| Revenue Streams | Van Ostaeyen et al. [31]; Renswoude et al. [7]; Tukker [36] |
| Additional Issues Related to Circular Economy | Material loops: EMF Vol. 1&2 [2,4]; Mentink [11]; Renswoude et al. [7]; Lacy et al. [28]; WRAP [29]; EMF Vol. 3 [1]; Govindan et al. [24]; El-Haggar [32]; EMF [23]; Freyermuth [68]; Scott [3]; Lacy et al. [25]; Planing [5]; |
| Adoption factors: Planing [5]; Scott [3]; El-Haggar [32]; Laubscher and Marinelli [22]; Lacy et al. [28]; Joustra et al. [16]; Jong et al. [14]; Renswoude et al. [7]; Barquet et al. [10]; Mentink [11]; Guinée [46]; EMF [23]; EMF [4]; EMF [6]; Parlikad et al. [45]; Stubbs & Cocklin [38]; Skelton and Pattis [73]; Winter [47] |
2.3. Synthesis and Development of the Framework of Circular Business Model
Pursuing better answers to the research questions resulted in undertaking step 3. This step synthesizes how the circular economy principles apply to each component of the business model, and proposes the new components of the circular business model. These components pertain to the ways in which the CE principles exceeded the popular business model framework. Additionally, advantages and disadvantages of the new framework were outlined. These results are presented in the Section 4.3. Research on Circular Business Models—The Review
3.1. Definitions
Although it is a contemporary movement, the circular economy is based on old ideas [74]; it is thus reasonable to outline its specificity. This includes the definitions, the origins of the movement, and its main principles. CE was probably first defined and conceptualized in the Ellen MacArthur Foundations report, as “an industrial system that is restorative or regenerative by intention and design” [4]. This means pursuing and creating the opportunities for a shift from an “end-of-life” concept to Cradle-to-Cradle™, from using unrenewable energy towards using renewable, from using toxic chemicals to their elimination, from much waste to eliminating waste through the superior design of materials, products, systems, and also business models [4]. The circular economy becomes a new vision of the treatment of resources, energy, value creation and entrepreneurship [16].Linder and Williander [18] define a circular business model as “a business model in which the conceptual logic for value creation is based on utilizing the economic value retained in products after use in the production of new offerings” (p. 2). Mentink [11] defines CE as “an economic system with closed material loops,” and a circular business model as “the rationale of how an organization creates, delivers and captures value with and within closed material loops” (p. 35). He argues that circular business models do not necessarily aim to balance ecological, social and ecological needs, in contrast to business models, although at the same time they can serve sustainability goals [11]. However, another approach is also supported in the literature. Most recently, Scott [3] provided a useful conceptualization of CE in relation to sustainability. He argues for understanding the circular economy as “a concept used to describe a zero-waste industrial economy that profits from two types of material inputs: (1) biological materials are those that can be reintroduced back into the biosphere in a restorative manner without harm or waste (i.e: they breakdown naturally); and, (2) technical materials, which can be continuously re-used without harm or waste” (p. 6). In turn, he defines sustainability as the capacity to continue into the long term and, at the same time, as a mechanism that enables the circular economy to work [3].
The general concept underlying the circular economy has been developed by many schools of thought, such as Regenerative Design, Performance Economy, Cradle to Cradle, Industrial Ecology, Biomimicry, Blue Economy, Permaculture, Natural Capitalism, Industrial Metabolism and Industrial Symbiosis [2,4,17,19,20]. Those schools of thought are complementary to each other and provided the foundation for the main principles of this new approach to economy [2,4,7,16]:
- (1)
- Design out waste/Design for reuse
- (2)
- Build resilience through diversity
- (3)
- Rely on energy from renewable sources
- (4)
- Think in systems
- (5)
- Waste is food/Think in cascades/Share values (symbiosis)
This variety of concepts supports Scott’s [3] approach to the relation between sustainability and circular economy.
3.2. Components
The fundamental constructs and constituent elements of circular business models can be derived from the main principles of the circular economy. In the literature, such components are understood and defined variously, for instance: the ReSOLVE (regenerate, share, optimize, loop, virtualize, exchange) framework [4,23], ways of circular value creation [7], normative requirements for business models [21], and areas for integration [22].There are six business actions to implement the principles of the circular economy and which represent major circular business opportunities depicted by the ReSOLVE framework [23]. Regenerate signifies the shift to renewable energy and materials. It is related to returning recovered biological resources to the biosphere. Thus it aims to reclaim, retain, and regenerate the health of ecosystems. Share actions aim at maximizing utilization of products by sharing them among users. It may be realized through peer-to-peer sharing of private products or public sharing of a pool of products. Sharing means also reusing products as long as they are technically acceptable to use (e.g., second-hand), and prolonging their life through maintenance, repair, and design-enhancing durability. Optimise actions are focused on increasing the performance/efficiency of a product and removing waste in the production process and in the supply chain. They may also be related to leveraging big data, automation, remote sensing, and steering. What is important is that optimization does not require changing the product or the technology. Loop actions aim at keeping components and materials in closed loops. The higher priority is given to inner loops. Virtualize actions assume to deliver particular utility virtually instead of materially. Exchange actions are focused on replacing old materials with advanced non-renewable materials and/or with applying new technologies (e.g., 3D printing). It may also be related to choosing new products and services [23].
Renswoude et al. [7] identify similar ways of circular value creation, pertaining to the short cycle, where products and services are maintained, repaired and adjusted, to the long cycle which extends the lifetime of existing products and processes, to cascades based on creating new combinations of resources and material components and purchasing upcycled waste streams, to pure circles in which resources and materials are 100% reused, to dematerialized services offered instead of physical products and to production on demand.
Other studies identified four normative requirements for business models for sustainable innovation, grounded in wider concepts such as sustainable development [21]. The first is a value proposition reflecting the balance of economic, ecological and social needs. The second is a supply chain engaging suppliers into sustainable supply chain management (materials cycles). The third is a customer interface, motivating customers to take responsibility for their consumption. The fourth is a financial model, mainly reflecting an appropriate distribution of economic costs and benefits among actors involved in the business model [21]. Boons and Lüdeke-Freund [21] (p. 13) also noticed that comparable conceptual notions of sustainable business models did not exist.
Mentink [11] (p. 34) used a similar approach to the business model as Frankenberger et al. [75], and outlined the changes of business model components needed for developing a more circular service model, such as:
- value propositions (what?)—products should become fully reused or recycled, which requires reverse logistics systems, or firms should turn towards product-service system (PSS) and sell performance related to serviced products
- activities, processes, resources and capabilities (how?)—products have to be made in specific processes, with recycled materials and specific resources, which may require not only specific capabilities but also creating reverse logistics systems and maintaining relationships with other companies and customers to assure closing of material loops
- revenue models (why?)—selling product-based services charged according to their use
- customers or customer interfaces (who?)—selling “circular” products or services may require prior changes of customer habits or, if this is not possible, even changes of customers
Laubscher and Marinelli [22] identified six key areas for integration of the circular economy principles with the business model:
- (1)
- Sales model—a shift from selling volumes of products towards selling services and retrieving products after first life from customers
- (2)
- Product design/material composition—the change concerns the way products are designed and engineered to maximize high quality reuse of product, its components and materials
- (3)
- IT/data management—in order to enable resource optimization a key competence is required, which is the ability to keep track of products, components and material data
- (4)
- Supply loops—turning towards the maximization of the recovery of own assets where profitable and to maximization of the use of recycled materials/used components in order to gain additional value from product, component and material flows
- (5)
- Strategic sourcing for own operations—building trusted partnerships and long-term relationships with suppliers and customers, including co-creation
- (6)
- HR/incentives—a shift needs adequate culture adaptation and development of capabilities, enhanced by training programs and rewards
One of the most important components of circular business models is the reversed supply-chain logistics. A comprehensive review on this subject has been done by Govindan, Soleimani, and Kannan [24].
3.3. Taxonomies
In the literature, there are several propositions of how to categorize business models. Most of them are very similar and use the criterion of the source of value creation (e.g., [4,7,25]). Few authors proposed other criteria, such as sources of value in a product-service systems [5,14,30], before-the-event techniques of cleaner production [32], design strategies for product life extension [33], cycle of product/component/material circulation in material loops [5], or mixed criteria [12]. However, the typologies are somewhat overlapping, and the distinction criteria are sometimes blurred. An overview of the circular business models, systematized according to the ReSOLVE framework, is presented in Table 3.| Classification Criteria | Model | Literature Sources | Explanation | Example(s) |
|---|---|---|---|---|
| Regenerate | Energy recovery | Damen [27]; Lacy et al. [28] | The conversion of non-recyclable waste materials into useable heat, electricity, or fuel | Ralphs and Food 4 Less installed an “anaerobic digestion” system |
| Circular Supplies | Lacy et al. [28]; EMF [23] | Using renewable energy | Iberdrola | |
| Efficient buildings | Scott [3] | Locating business activities in efficient buildings | Phillips Eco-Enterprise Center | |
| Sustainable product locations | Scott [3] | Locating business in eco-industrial parks | Kalundborg Eco-industrial Park | |
| Chemical leasing | Moser and Jakl [34] | The producer mainly sells the functions performed by the chemical, so the environmental impacts and use of hazardous chemical are reduced | Safechem | |
| Share | Maintenance and Repair | Lacy et al. [28]; WRAP [76]; Bakker et al. [33]; Planing [5]; Damen [27] | Product life cycle is extended through maintenance and repair | Patagonia, Giroflex |
| Collaborative Consumption, Sharing Platforms, PSS: Product renting, sharing or pooling | Lacy et al. [28]; Lacy et al. [25]; WRAP [76]; Planing [5]; Tukker [36]; Jong et al. [14] | Enable sharing use, access, or ownership of product between members of the public or between businesses. | BlaBlaCar, Airbnb, ThredUP, | |
| PSS: Product lease | Tukker [36]; Jong et al. [14]; WRAP [76]; | Exclusive use of a product without being the owner | Mud Jeans, Dell, Leasedrive, Stone Rent-a-PC | |
| PSS: Availability based | Van Ostaeyen, et al. [31]; Mentink [11] | The product or service is available for the customer for a specific period of time | GreenWheels | |
| PSS: Performance based | Van Ostaeyen, et al. [31]; Zairul et al. 2015 [52] | The revenue is generated according to delivered solution, effect or demand-fulfilment | Philips’s “Pay per Lux” solution; the need for new housing model for young starters in Malaysia | |
| Incentivized return and reuse or Next Life Sales | WRAP [76]; Mentink [11]; Lacy et al. [25]; Damen [27] | Customers return used products for an agreed value. Collected products are resold or refurbished and sold | Vodafone Red Hot, Tata Motors Assured | |
| Upgrading | Planing [5]; Mentink [11] | Replacing modules or components with better quality ones | Phoneblocks | |
| Product Attachment and Trust | Mentink [11] | Creating products that will be loved, liked or trusted longer | Apple products | |
| Bring your own device | WRAP [76] | Users bring their own devices to get the access to services, | Citrix pays employees for bringing own computers | |
| Hybrid model | Bakker et al. [26] | A durable product contains short-lived consumables | Océ-Canon printers and copiers | |
| Gap-exploiter model | Bakker et al. [26]; Mentink [11] | Exploits “lifetime value gaps” or leftover value in product systems. (e.g., shoes lasting longer than their soles). | printer cartridges outlasting the ink they contain | |
| Optimise | Asset management | WRAP [76] | Internal collection, reuse, refurbishing and resale of used products | FLOOW2, P2PLocal |
| Produce on demand | Renswoude et al. [7]; WRAP [76], Scott [3] | Producing when demand is present and products were ordered | Alt-Berg Bootmakers, Made, Dell Computer Company | |
| Waste reduction, Good housekeeping, Lean thinking, Fit thinking | Renswoude et al. [7]; Scott [3]; El-Haggar [32]; Bautista-Lazo [35] | Waste reduction in the production process and before | Nitech rechargeable batteries | |
| PSS: Activity management/outsourcing | Tukker [36] | More efficient use of capital goods, materials, human resources through outsourcing | Outsourcing | |
| Loop | Remanufacture, Product Transformation | Damen [27]; Planing [5]; Lacy et al. [25] | Restoring a product or its components to “as new” quality | Bosch remanufactured car parts |
| Recycling, Recycling 2.0, Resource Recovery | Lacy et al. [25] Damen [27] Planing [5]; Lacy et al. [28] | Recovering resources out of disposed products or by-products | PET bottles, Desso | |
| Upcycling | Lacy et al. [28] Mentink [11]; Planing [5] | Materials are reused and their value is upgraded | De Steigeraar (design and build of furniture from scrap wood) | |
| Circular Supplies | Renswoude et al. [7]; Lacy et al. [28] | Using supplies from material loops, bio based- or fully recyclable | Royal DSM | |
| Virtualize | Dematerialized services | WRAP [76]; Renswoude et al. [7] | Shifting physical products, services or processes to virtual | Spotify (music online) |
| Exchange | New technology | EMF [6] | New technology of production | WinSun 3D printing houses |
3.4. Conceptual Models
The relationships between constituent elements of a circular business model have been conceptualized in the literature. Every business model is both linear and circular to some extent [7,11]. This is because every company optimizes its processes, virtualizes products or processes (using e-mails instead of traditional letters) and/or uses some resources from material loops, and thus introduces some principles of the circular economy, albeit not necessarily deliberately. Renswoude et al. [7] put it differently—“100% circular business models do not exist (yet). Not creating any waste at all is difficult to achieve for physical and practical reasons (p. 2)”. For this reason, the main conceptual frameworks of business models apply to the circular economy. However, some frameworks of circular business models have been developed for either type.There are quite many conceptual frameworks of business models in general [75,77,78,79,80,81,82]. Thus, a further systematization became a reasonable direction of research. And so, there are two more comprehensive propositions, one by Wirtz [9], and one by Osterwalder and Pigneur [8]. Wirtz (2011) [9] made a systematic overview of the business model concept, and proposed an integrated business model consisting of nine partial models divided into three main components—strategic, customer and market, value creation. The strategic component comprises three models regarding the strategy (mission, strategic positions and development paths, value proposition), resources (core competencies and assets), and network (business model networks and partners). The customer and market components consist of customer model (customer relationships/target group, channel configuration, customer touchpoint), market offer model (competitors, market structure, value offering/products and services), and revenue model (revenue streams and revenue differentiation). The value creation component encompasses production of goods and services (manufacturing model and value generation), procurement model (resource acquisition and information), and financial model (financing model, capital model and cost structure model).
A more recognized and applied framework of a business model distinguishes nine building blocks [83], and is conceptualized as the business model canvas (BMC) [8]. The BMC consists of [8,10]:
- (1)
- Customer segments that an organization serves
- (2)
- Value propositions that seek to solve customers’ problems and satisfy their needs
- (3)
- Channels which an organization uses to deliver, communicate and sell value propositions
- (4)
- Customer relationships which an organization builds and maintains with each customer segment
- (5)
- Revenue streams resulting from value propositions successfully offered to customers
- (6)
- Key resources as the assets required to offer and deliver the aforementioned elements
- (7)
- Key activities which are performed to offered and deliver the aforementioned elements
- (8)
- Key partnerships being a network of suppliers and partners that support the business model execution by providing some resources and performing some activities
- (9)
- Cost structure comprising all the costs incurred when operating a business model
Most recently, value proposition design has been developed, and comprises of six building blocks, which are a detailed description of the two BM canvas blocks—value propositions and customer segments [37]. Value proposition is composed of the products and services offered to the customer, the relievers of customers pains, and the creators of customer gains pertaining to the tasks and jobs he or she needs to accomplish with the assistance of the offered product or service. Thus, on the customer’s side are the jobs, pains and gains related to doing the jobs. The visualization of both canvases are presented in Figure 2.
Figure 2. The Business Model Canvas and the Value Proposition Canvas. Source: Osterwalder and Pigneur [8] and Osterwalder et al., (2014) [37]. Reproduced with permission from Strategyzer.com and Strategyzer AG.
Some other conceptual frameworks exist in the literature related to sustainability. For instance, Stubbs and Cocklin [38] developed a case study-based conceptualization of a sustainability business model, consisting of two types of attributes—structural and cultural ones. Each type has its economic, environmental, social, and holistic characteristics. Structural attributes are depicted by:
- Economic characteristics, such as external bodies expecting triple bottom line performance, lobbying for changes to taxation system and legislation to support sustainability, keeping capital local
- Environmental characteristics, such as a threefold strategy (offsets, sustainable, restorative), closed-loop systems, implementation of services model, operating in industrial ecosystems and stakeholder networks
- Social characteristics, such as understanding stakeholder’s needs and expectations, educating and consulting stakeholders
Holistic characteristics, such as cooperation and collaboration; triple bottom line approach to performance; implementing demand-driven model; adapting organization to sustainability.
Cultural attributes are depicted by:
- Economic characteristics, such as considering profit as a means to do something more (“higher purpose”), not as an end, which is also a reason for shareholders to invest
- Environmental characteristics, such as treating nature as a stakeholder
- Social characteristics, such as balancing stakeholders’ expectations, sharing resources among stakeholders, and building relationships
- Holistic characteristics, such as focusing on medium to long-term effects, and on reducing consumption
Most recent contributions to conceptual models concern the dynamics between components of the business model. For instance, Roome and Louche [39] developed process model of business model change for sustainability, which explains how new business models for sustainability are fashioned through the interactions between individuals and groups inside and outside companies. Gauthier and Gilomen [40] analyzed transformations of the elements of sustainable business model and identified a typology of such changes (see Subsection 3.8 in this paper). Abdelkafi and Täuscher [41] developed a system dynamics-based representation of business models for sustainability. Not only has the dynamic of internal business model components been researched, but also the dynamics in relation to the business model environment. One of the key issues in this regard pertains to networks. Jabłoński [42] outlined the process of transition from an idea to the operationalization of the business model by searching for business model components from the network. However, the static approach is also being investigated. For example, Upward and Jones [43] developed the strongly sustainable business model ontology. Another approach proposed by Bautista-Lazo and Short [84] conceptualized an All Seeing Eye of Business model, which addresses the types of waste and their potential as a profit or loss generator.
3.5. Design Methods and Tools
There are several design methods and tools for the business model in the literature. Some of them focus on enhancing the design process [3,7,8,10], and others are used in particular situations and for particular business models [32,42,46].Joustra et al. [16] and Jong et al. [14] identified five steps to support for small and medium enterprises (SMEs) to enter the circular economy. The first two steps comprise reading about the CE, and learning about the readiness of the company, partners and stakeholders in the supply chain for CE. The next two steps suggest evaluating redesign opportunities that might bring the products into a more circular business model, and to understand the service that a company could potentially deliver and how the model needs to be redesigned to enable this. The last step tests whether the value delivered is the value that customers expect and will pay for.
Scott [3] proposed the 7-P model as a starting point toward understanding and applying the mechanism of the circular economy in a business. This model takes the practitioner’s approach and describes seven main components, which can be divided into three steps. The first is to learn and understand the fundamentals of the circular economy, and what the change will concern, and decide on establishing sustainability as an objective (prepare). The next step is to organize and implement the mechanisms of the circular economy related to the process, preservation, people, place, product, and production. The last step is to enable and support implementation of CE, mainly through building teams and managing change (People).
Renswoude et al. [7] developed the business model scan, a methodology to enhance a transition of the company into a more circular form. It consists of six process stages about which many questions are asked. Those questions are related to value proposition, design, supply, manufacturing, use, and next life. Osterwalder and Pigneur [8] proposed five stages of business model design process, encompassing mobilize, understand, design, implement, and manage. This methodology is supported by the business model canvas (described in Section 3.4). BMC has been applied to research and design circular business models [10,11]. Jablonski [42] distinguished eleven stages of the design and operationalization of the company’s technological business model embedded in the network. Parlikad et al. [45] identified the information requirements for end-of-life decision making and established a possible set of characteristics of a lifecycle information system to support management. They also reviewed existing product lifecycle information systems and divided them into two categories. Design/disassembly data-sharing systems encompass: Inverse Manufacturing Product Recycling Information System (IMPRIS), Recycling Passport, Products Lifecycle Management System (PLMS), Integrated Recycling Data Management System (ReDaMa). Lifecycle information monitoring systems comprises of: Information System for Product Recovery (ISPR), Life Cycle Data Acquisition System (LCDA), Green Port [45]. Cleaner production audits are undertaken to identify opportunities for cleaner production. The methodology for the cleaner production opportunity assessment has been outlined by El-Haggar [32] (p. 29), and consists of many activities related to and focused on the following: team, pre-audit, surrounding environment, operations and processes, inputs and outputs, wasteful processes, material and energy balance, opportunities, priorities, implementation, assessment, process sustainability, sustainable development. Another important method is life cycle assessment [85] which is explained as “a tool for the analysis of the environmental burden of products at all stages in their life cycle—from the extraction of resources, through the production of materials, product parts and the product itself, and the use of the product to the management after it is discarded, either by reuse, recycling or final disposal (in effect, therefore, ‘from the cradle to the grave’)” [46] (pp. 5–6). Scott [3] (p. 81) also suggests that environmental audits, such as compliance audit, waste audit, waste disposal audit, water audit, can be used. Mentink [11] discussed a few other methods and tools, such as: New Framework on Circular Design, Practical Guide for PSS Development, Circular Economy Toolkit, Play it Forward, 4-I Framework, and Sustainable Business Model Canvas.
3.6. Adoption Factors
Factors affecting CBM adoption are mostly related to general factors [5,47], human resources [3,16,28], political system and legislation [3,6], IT and data management [3,45], and business risks [11]. There are also crucial socioeconomic implications, justifying the efforts towards CE [4,7,22], and other enablers such as leadership, collaboration, motivation through the concept itself, and customer behavior [53].General factors encompass conditions which need to be fulfilled to secure profitability of closed circles. Winter [47] (p. 16) points out five of them: sufficiently valuable materials/products, control of product or material chain, ease of reuse, remanufacture or recycle materials/products, predictable demand for future products, keeping materials/products concentrated and uncontaminated. Planing [5], however, argued that customer irrationality, conflict of interest within companies, misaligned profit-share along the supply chain, and geographic dispersion could be the reasons for rejecting circular business models. Scheepens et al. [48] argue that transition to CE is impacted by different factors on several levels: societal, regulatory, services and infrastructure, and product and technology. Sivertsson and Tell [71] identified barriers to business model innovation in the agricultural context for each of the nine building blocks of the business model canvas (by Osterwalder and Pigneur [8]). Pearce identified six kinds of customers whose needs may be satisfied by the companies offering remanufactured products. These types comprise the customers who (1) need to retain a specific product because it has a technically defined role in their current processes; (2) want to avoid the need to re-specify, re-approve or re-certify a product; (3) make low utilization of new equipment; (4) wish to continue using a product which has been discontinued by the original manufacturer; (5) want to extend the service lives of used products, whether discontinued or not; and (6) are interested in environmentally friendly products [51]. Linder and Williander [18] outlined challenges regarding remanufacturing, such as: considerable expertise and knowledge of the product; efficient product retrieval; suitable types of products; risk of cannibalization if the new, longer-lasting products reduce sales of the previous products; fashion changes; a financial risk for the producer if the offer is to be rented; increased operational risk; lack of supporting law, policy and regulations; and compatibility with the business models of partners.
Regarding the role of human resources in a company shift towards the circular economy, various suggestions have been made. On the basis of successful waste elimination schemes, Scott [3] formulated general recommendations for creating teams related to team members and team size, volunteers, goals, motivation, maintaining links with organization, organizing team meetings, positive thinking, and leadership. Lacy et al. [28] (p. 18) identified five capabilities of successful circular leaders (business planning and strategy, innovation and product development, in sourcing and manufacturing, sales and marketing, reverse logistics and return chains). Other researchers also emphasized the role of leadership, mostly pertaining to the appreciation of the new strategic direction, understanding its benefits and risks, and the ability to establish a common understanding in the business [53,54].
Joustra et al. [16] (p. 11) identified eight elementary skills for any circular economy project team, such as: entrepreneurial and developing, craftsmanship aimed at product/services, systems thinking and capability of identifying causal loops, future oriented and out-of-the-box, celebrating diversity, addressing insecurities, designing circular systems, products and services, and being creative, innovative and connected. Laubscher and Marinelli [22] give some insights from the practice and emphasized the role of adequate culture adaptation and development of capabilities in a BM transformation towards CE. This can be obtained through dedicated training programs, performance and rewards schemes, personal targets and bonuses for sales managers.
Others argue that policymakers at all government levels (municipal, regional, national, and supranational) play an important role in the circular economy [3,6]. There are two broad and complementary policymaking strategies to accelerate the circular economy: fixing market and regulatory failures, and stimulating market activity by, for example, setting targets, changing public procurement policy, creating collaboration platforms and providing financial or technical support to businesses [6].
Parlikad, et al. [45] and Scott [3] (p. 79) argue that IT and data management systems are essential for the circular economy, because they allow to keep track of products, components and material data. This strongly supports effective reverse logistics systems, material loops (also cross-industry) and reuse of components.
Some business risks of service models (or PSS) have also been identified in the literature. They are related to the fact that (a) owning a product is preferred if the user is emotionally attached to the product or the product has an important intangible value, impacting, for instance, the owner’s social status; (b) result or function-oriented services need a good explanation and description, which may increase transaction costs; (c) the service provider must predict and control the risks, uncertainties and responsibilities related to selling a result-oriented service [11,14,16]. Moreover, validating a circular business model always has a higher business risk than validating a corresponding traditional, linear business model [18].
Regarding the impact of the circular economy, there are three main winners: economies, companies and user/consumers [3,4,7,55]. CE advantages for economies are related to e.g., the impact on economic growth, material cost savings, mitigation of price volatility and supply risks, significant job growth in services, employment market resilience [4,49]. Laubscher and Marinelli [22] point that companies can gain financial and reputational value. Others argue that CE will give the companies new profit possibilities, increase competitive advantage and build resilience against several strategic challenges [4,56,57]. Detailed advantages could concern: innovation and competitive advantage, additional revenue streams, long-term contracts, customer loyalty and feedback, multiple benefits of internal resource management, and beneficial partnerships throughout the value chain [7,58,59,60]. Customer and user benefits mainly comprise of increased choice at lower cost; however, there are also some social benefits, like a contribution against climate change [4,52].
Importantly, adaptation factors change in time and those changes also impact the evolution of business models [50].
3.7. Evaluation Models
The criteria for assessing the feasibility, viability, and profitability of circular business models must be adjusted to the micro, meso and macro-level of implementation [47]. On the micro-level Laubscher and Marinelli [22] argue for measuring the reduced ecological footprint, direct financial value through recovery of materials and assets, and top line growth through new business models. A more extended set of key performance indicators could encompass a percentage of: revenues from repairs, reused parts, refurbished products, recycled material used product value after period X, revenue from second-hand products, times of reuse of resource, technical lifetime value of by-products, by-products used, separability of resources, toxic materials used, and products leased [11]. Anderson and Stavileci [61] proposed several criteria for evaluation of the business model’s validity for the circular economy, such as: turnover possibility, margins, capital intensiveness, implementation time, dependence on supplier, possible usage of recycled materials, usage of unsustainable materials, benefits from additive manufacturing, percentage of lifecycle, product oriented, and service oriented. There are also some guidelines for accounting the costs of material flow (MFCA) [62,63,64].On the macro-level, there are several measurements for three CE principles [23]. Measurements concerning the principles of preservation and enhancing natural capital by controlling finite stocks and balancing renewable resource flow, comprise degradation-adjusted net value add (NVA) as a primary metric, and annual monetary benefit of ecosystem services, annual degradation, and overall remaining stock as secondary metrics. Measurements for the principle of optimization of resource yields by circulating products, components and materials in use at the highest utility at all times in both technical and biological cycles, encompass as a primary metric GDP-generated per unit of net virgin finite material input, and product utilization, product depreciation/lifetime, and material value retention or value of virgin materials as secondary metrics. Measurements for the principle of fostering system effectiveness by revealing and designing out negative externalities, consist of cost of land, air, water, and noise pollution, as a primary metric, and toxic substances in food systems, climate change, congestion, and health impacts as secondary metrics [23].
3.8. Change Methodologies
Scott [3] (pp. 103–109) argues that basic change management theories, like the Force Field Theory, Three-Stage Approach to Change Behavior, sources of staff resistance to change, can be successfully applied to manage the transition from a linear business model towards a circular one. However, other studies provide theories more specific to CE. For example, the model of the process of changing business model for sustainability explains how new business models for sustainability are fashioned through the interactions between individuals and groups inside and outside companies [39]. Gauthier and Gilomen [40] identified a typology of business model transformations toward sustainability:- (1)
- Business model as usual—if there are no transformations to business model elements
- (2)
- Business model adjustment—if marginal modifications to one element of BMs occur
- (3)
- Business model innovation—if major BM transformations were implemented
- (4)
- Business model redesign—if a complete rethinking of organizations’ BM elements results in radically new value propositions
4. Circular Economy and the Components of Business Model
4.1. Value Propositions Fitting Customer Segments (Value Proposition Design)
The core component of the circular business model is the value proposition. Circular value proposition offers a product, product-related service or a pure service [14]. This offer must allow the user/consumer to do what is needed, reduce inconveniences which the consumer/user would experience, and provide additional benefits [37].Circular products, although ownership-based [5], have several specific features related to the CE principles. Circular products enable product-life extension through maintenance, repair, refurbishment, redistribution, upgrading and reselling [5,7,28,33,45]. They are designed to enhance reusing, recycling, and cascading. This requires a modular design and choosing materials that allow cascading, reusing, remanufacturing, recycling, or safe disposal. Thus, such products are 100% ready to circulate in the closed material loops. Moreover, product design should allow using less raw material or energy or to minimize emissions [3,25,32]. Circular products can be also dematerialized and offered not as physical but as virtual products [4,7].
In a product-service system a company offers access to the product but retains its ownership. It is an alternative to the traditional model of “buy and own”. This is a way of reducing customer pains, creating gains, and getting the jobs done through offering product-oriented services or advice, use-oriented services including product leasing, renting, pooling, and pay-per-service unit, or result-oriented services, comprising outsourcing and functional result [14,25,28,30,36]. Some examples comprise: Philips pay-per light [22] or GreenWheels’ shared car use, hours of thrust in a Rolls-Royce, or “Power-by-the-Hour” jet engines [26].
Circular value propositions related to services may concern shifting their traditional form to a virtual one (e.g., virtual travel) [4,6,7].
Collaborative consumption related to product sharing/renting or product pooling can bring cost savings, services tailored for customer needs, and additional benefits. For instance, BlaBlaCar offers not only cheap transportation possibilities and route connections unavailable by public transport, but also social gains (see blablacar.com). Some other sharing-based value propositions concern sharing residence, parking, appliances/tools sharing, office, and flexible seating, which may require some specially developed platforms [4,7,28].
Usually there are some incentives offered to the users/consumers [76]: for example, buy-back programs like Vodafone—New Every Year/Red Hot [1]. In this case, incentives are a source of value for the customer (part of value proposition), and products, components or materials collected back contain a value retrieved by the company.
The value proposition must be appropriate for particular customer segments, for specific types of customers [51].
4.2. Channels
One of the strongest shifts towards a circular business model regarding channels is virtualization. This means that an organization can sell a virtualized value proposition and deliver it virtually (selling digital products, like music in mp3 format) and/or sell value propositions via virtual channels (online shops selling material products) [6]. Another possibility is to communicate virtually with the customer (e.g., using web advertisements, e-mails, websites, social media, video conferences) [23,69].4.3. Customer Relationships
Building and maintaining relationships with customers can underlie the main principle of the circular economy—eliminating waste—twofold. Those two options encompass producing on order, and engaging customers to vote for which product to make [7]. Additionally, a switch to recycling 2.0 may enhance social-marketing strategies and leverage relationships with community partners [25,69].4.4. Revenue Streams
Revenue streams are essentially the ways in which a company makes money. There are several circular propositions, mainly associated with the product-service systems [7,31]. The first is an input-based PSS, like pay per product or pay per service. The second is availability-based PSS, encompassing a subscription-based rental where, against a low, periodic fee, consumers can use a product or service; or a progressive purchase, where customers periodically pay small amounts before the purchase. The third is usage-based PSS like pay per use, which is a one-time payment to use a product or service. The fourth one is performance-based, like performance-based contracting. However, several performance-based PSSes are possible, like solution-oriented (e.g., selling a promised level of heat transfer efficiency instead of selling radiators), effect-oriented (e.g., selling a promised temperature level in a building instead of selling radiators), and demand-fulfilment oriented (e.g., selling a promised level of thermal comfort for building occupants instead of selling radiators) [31]. Two traditional options of revenue streams concern selling pure products or pure services [36]. Revenue streams depend on the value proposition.Moreover, revenue streams may be related to retrieved value, generated from products, components and/or raw materials collected back. For example product components, when collected back, are resold after they were restored to “as-new” quality, or remanufactured, or used to create a new product if they carry a high value [5,25]. Despite how low or high the value, it must be sufficient to make the material loops economically reasonable. Retrieved value may also be related to energy captured from waste disposal [4].
4.5. Key Resources
The assets required to create, offer and deliver value propositions via chosen channels, to build and maintain relationships and to receive revenue flows, correspond with the principles guiding the circular economy in two major ways. One is focused on input choices and the second on regenerating and restoring the natural capital.The input choices are related to changing input materials and products. This can be done through so-called circular sourcing, which applies the principle of using only products or materials obtained from closed material loops along four circular flows [5,7,28]. Another way to achieve this is direct substitution of resources with better-performing materials, which are “less harmful to the environment, more feasible to use and have the same or better technical requirements” [32] (p. 27). Next option is direct virtualization of materials, as for instance through digitalization [23,68].
Natural capital regeneration and restoring concerns using energy from renewable sources, land restoration or reclamation, saving water, operating in more efficient buildings, and choosing sustainable production locations like eco-parks [3].
4.6. Key Activities
The key activities which directly or indirectly lead to creating, offering and delivering the value propositions, may apply the CE principles in several ways. Some are oriented on increasing performance, product design, technology exchange, and the other on remanufacturing, recycling or even lobbying.Increasing performance can be obtained through good housekeeping, better process control, equipment modification and technology changes, sharing and virtualization. Good housekeeping and process control involve not only optimization of the process by elimination of any fault that would result in unnecessary losses, like spills, leakage, overheating etc., but also effective and efficient planning and regulating of the process to ensure optimal conditions such as temperature, pH, pressure, water level, time, etc. [32]. This requires, for instance, continuous monitoring and management, a regular preventive maintenance program, raising staff environmental awareness, and incentive mechanisms, and is supported by lean thinking and lean management [3,32]. Recently, another way of increasing performance has been introduced—the “bring your own device” model [76]. It assumes that users bring their own devices in order to get the access to services, and thus the quantity of products required to meet market need is being reduced. An example is Citrix where employees are paid for bringing their own computers into the company to use on the company’s network for work and home [76]. Equipment modification and technology changes improve the production process or replace one with another, and in turn increase efficient utilization of raw materials, water, energy, reduce emissions and eliminatestoxic materials from production [32]. A good example is using 3D printing to produce what is needed [7]. Increasing performance may be related also with sharing and virtualizing office space through flexible seating, desk-sharing, office hoteling, tele-working, audio and video conferences, the “internet of things”, big data and machine learning [23,28,67].
Appropriate product design enables using less raw material or energy, to reduce emissions and toxic materials, prolonging product life, eliminating waste before resource-life extension, and to circulate the product, components and materials in a 100% closed material loop, according to the Cradle-to-Cradle concept [1,3,16,25,32].
Moreover, sometimes lobbying for the changes of legislation and political incentives to accelerate the circular economy is necessary [3,4,6,7,22]. When a company is directly engaged in lobbying, then it becomes the key activity. Otherwise lobbying depends on third-party entities and is considered as an adaptation factor.
4.7. Key Partnerships
Cooperative networks allow businesses to receive advantages from supplies, and support a company in research, product design, marketing, office support, supply routes, financial functions, production processes, and management [3,16]. Thus, collaboration enhances obtaining key resources and performing key activities. For instance, off-site recycling is done by other parties that recycle the industrial wastes at the post-consumer stage or recycle the specific wastes, which then are sold to other industries [32]. Collaborative production, based on the cooperation in the production value chain, allows the materials to circulate in a so-called closed material loop [7]. Sheu [65] argues that collaborative relationships play an important role in the green supply chains. Robinson et al. [66] showed that business models for solar-powered charging stations to develop infrastructure for electric vehicles may need a strong engagement of public organizations as collaborating partners. Considering the value chain and supply chain, the more circular partners in those chains, the more circular the economy. The “butterfly diagram” developed by the Ellen MacArthur Foundation shows the key role of manufactures and recycling companies [4]. Without collaboration, achieving circularity is hardly possible [53,54]. However, regarding cooperation types, different strategies support different business models [86].4.8. Cost Structure
The reviewed literature provided no good examples on how the cost structure can enhance implementation of CE principles. However, whenever a company decides to change the cost structure it might require further organizational changes, such as for materials, energy consumption, staff behavior etc., and in turn elicit more circular changes to the business model. This process could start with the analysis of the cost structure. In this regard, cost structure-related criteria can help to evaluate efficiency of optimization policies [11,22]. Cost structure is usually mentioned when the implications and potential benefits of CE are described. It may pertain to cost savings related to PSS or reverse material flow [62,63,64,70], production costs in agriculture [71], costs of product development [72], or investments [10].4.9. The Need for Additional Components of a Business Model Related to the Circular Economy
The literature review conducted allowed the identification of how the principles of the circular economy can be applied to the nine components of the business model [8]. An overview according to the ReSOLVE framework is presented in Table 4.| BM Components | Regenerate | Share | Optimize | Loop | Virtualize | Exchange |
|---|---|---|---|---|---|---|
| Partners | X | X | ||||
| Activities | X | X | X | X | ||
| Resources | X | X | X | X | ||
| Value proposition and Customer segments | X | X | X | |||
| Customer relations | ||||||
| Channels | X | |||||
| Cost structure | X | X | X | X | ||
| Revenue streams | X | X | ||||
| Potential to develop the BM framework | ||||||
| Take-back system | X | |||||
| Adoption factors | X | X | X | X | X | X |
Note: X indicates that the circular economy principles apply to the particular component of business model.
5. Conceptualizing the Framework of the Circular Business Model Canvas
5.1. Key Areas of Redesigning a Business Model Framework
The conducted study revealed two additional components of the business model framework in order to develop a circular business model framework. This section continues to build on the concept of the business model canvas [8], and describes the novelties and, as a result, proposes a circular business model canvas.5.2. Take-Back System
Material loops are the core idea of the circular economy [2,4,11]. This idea assumes that products, their components and/or materials can be cascaded (in case of biological nutrients), and reused/redistributed, remanufactured/refurbished, or recycled (in case of technical nutrients), which requires prior collecting back from the consumer and reverse logistics [4,7,24,28]. The principles of the Circular Economy applied to reverse logistics are related to take-back management, incentivized return and reuse, and collection of used products. For example I:CO is an H&M partner which collects used clothes, and Vodafone introduced the buy-back program New Every Year/Red Hot [1,76]. According to the direction of material flow in a supply chain, both forward and reverse are possible [24], but reversed logistics may require different partners, channels and customer relations, and thus a new component can be distinguished in order to differentiate the specificity of forward and reverse logistics.5.3. Adoption Factors
Due to the various reasons for rejecting circular business models [5], a company must anticipate and counteract them. There are internal and external factors affecting adaptation of a business model to the circular economy principles.Internal factors concern organizational capabilities to shift towards the circular economy business model. Such capabilities require intangible resources, like team motivation and organizational culture, knowledge and transition procedures. These components are based on developing human resources and team building, and the application of change management instruments [3,16,22,28,32,53], on using business models’ design methods and tools [3,7,8,10,11,14,16,46], and evaluation models [11,22,23].
External factors comprise technological, political, sociocultural, and economic issues [53]. Technological issues pertain to the possibilities to use adequate IT and data management technologies to support material tracking [3,22,45] and other specific technologies e.g., recycling [53,54], monitoring legislation and political incentives [3,6,53], and if necessary lobbying for them [38,73]. There are crucial socioeconomic benefits justifying the efforts of lobbying for the changes of legislation and political incentives to accelerate CE [3,4,6,7,22]. Another two groups of factors concern sociocultural issues, like customer habits and public opinion, and economic forces like predictable demand for future products or previous difficulties of business entities in adoption of CE principles [11,14,16,47,53,54]. Although the list of various factors is much wider and open-ended, Roos [53] identified a list of questions supporting practitioners in adopting circularity into business models.
5.4. The Framework of the Circular Business Model Canvas
The circular business model canvas is extended and adjusted to the circular economy version of the business model canvas developed by Osterwalder and Pigneur [8] and others [37]. It has eleven components; however, one component encompasses three sub-components. Those building blocks allow the designing of a business model according to the principles of circular economy, and consists of:- (1)
- Value propositions—offered by circular products enabling product-life extension, product-service system, virtualized services, and/or collaborative consumption. Moreover, this component comprises the incentives and benefits offered to the customers for bringing back used products
- (2)
- Customer segments—directly linked with value proposition component. Value proposition design depicts the fit between value proposition and customer segments
- (3)
- Channels—possibly virtualized through selling virtualized value proposition and delivering it also virtually, selling non-virtualized value propositions via virtual channels, and communicating with customers virtually
- (4)
- Customer relationships—underlying production on order and/or what customers decide, and social-marketing strategies and relationships with community partners when recycling 2.0 is implemented
- (5)
- Revenue streams—relying on the value propositions and comprising payments for a circular product or service, or payments for delivered availability, usage, or performance related to the product-based service offered. Revenues may also pertain to the value of resources retrieved from material loops
- (6)
- Key resources—choosing suppliers offering better-performing materials, virtualization of materials, resources allowing to regenerate and restore natural capital, and/or the resources obtained from customers or third parties meant to circulate in material loops (preferably closed)
- (7)
- Key activities—focused on increasing performance through good housekeeping, better process control, equipment modification and technology changes, sharing and virtualization, and on improving the design of the product, to make it ready for material loops and becoming more eco-friendly. Key activities might also comprise lobbying
- (8)
- Key partnerships—based on choosing and cooperating with partners, along the value chain and supply chain, which support the circular economy
- (9)
- Cost structure—reflecting financial changes made in other components of CBM, including the value of incentives for customers. Special evaluation criteria and accounting principles must be applied to this component
- (10)
- Take-Back system—the design of the take-back management system including channels and customer relations related to this system
- (11)
- Adoption factors—transition towards circular business model must be supported by various organizational capabilities and external factors
The first fit is between the value proposition, including the take-back system, and customer segments [37,51]. The second fit is between the cost structure and revenue streams. Simply the costs and revenues must be balanced, and the business model should indicate possibilities for profits [56,84]. This also pertains to other cycles of selling products (e.g., reused, recycled) [18,87]. The third fit is between the changes a company implements towards more circular business model and adaptation factors which can hinder this process (e.g., [3,6,11,16,22,50,53,56,57]).
Figure 4. The challenge of triple fit.
5.6. Advantages and Disadvantages of the Circular Business Model Canvas
The business model canvas developed by Osterwalder and Pigneur [8] can been used to design circular business models because every business model is to some extent linear and circular at the same time. This framework supports the process of designing a business model, but does not indicate how the principles of the circular economy or the business actions implementing CE are related to particular components of the business model. In turn, the ReSOLVE framework shows how the principles of the circular economy are translated into business actions implementing CE, but not in relation to business model components and design process. The circular business model canvas (CMBC) combines these two elements. There are some examples combining sustainability principles and business model components [88], albeit on a very general level and more useful for explanatory purposes than for supporting practitioners in designing business models. Hence, CBMC has some advantages as compared to the original canvas or the archetypes of sustainable business models.Firstly, CMBC points out the ways of applying circularity to each component of the business model. As a result, it provides the entrepreneur with a selection of possibilities to be applied to one, several or all of the business model components. This supports different speeds of change—radical and incremental. Secondly, CMBC comprises and emphasizes additional components which are crucial to CE—take-back systems and adoption factors. Thirdly, CMBC indicates the three main challenges in the transition from a linear to circular business model, which the original canvas does not include. Fourthly, it combines the original components of the canvas with CE principles in one framework, which as a practical tool is easier and more user friendly than the triple-layered business model canvas (TLBMC) aimed to support the creation of sustainable business models [89].
There are also some disadvantages of CBMC. Due to its focus on CE principles, it is less useful in designing linear business models. Moreover, the new framework is also more complex, and thus more difficult to apply than the original one. Besides, this is a conceptualization, so its real usability in designing processes has yet to be empirically verified.
6. Future Research
This study was based on the literature review which implies two major limitations. First, it comprises mainly the literature related to the circular economy. Because there is some disagreement in the literature surrounding the questions whether and how circular economy and sustainability are linked and overlapping concepts [3,11], the wider literature on sustainable business models [21,41,90,91] was considered here to a lesser extent. Moreover, there is a substantial body of literature related to each school of thought underlying the circular economy, especially industrial ecology, industrial symbiosis, industrial metabolism, and cleaner production. Each and within each of them there is enough research to conduct comprehensive review studies. Govindan, Soleimani, and Kannan’s [24] study is a good example of such a review. This literature was also considered here to a lesser extent, due to intentional focus on circular economy, and inclusion of those concepts in the literature on circular economy. The second limitation of this study pertains to the lack of empirical evidence; further research could therefore focus on empirical verification of the applicability of the proposed framework of the circular business model, in various business settings, especially of the new components like retrieved value proposition which requires empirical verification and further cognition. A detailed empirical investigation of the value proposition design in the context of the circular economy would be very interesting and promising. Does value proposition design need to be adjusted to the circular economy? What are the customer’s pains and gains related to the circular economy and how could a fit with value proposition be achieved? In this regard, the newest book by Osterwalder et al. [37] provides a good starting point to consider. Another direction could explore how the three fits (in the triple fit challenge) are interrelated. Some critical success factors for circular business models could be derived from such research. A heavily underexplored area is related to applying circularity to business models of public sector organizations and also non-governmental organizations. One of many possible routes of investigation is how the public sector and NGOs may benefit from partnerships with business [66,92].7. Conclusions
There are two very vital areas of managerial practice which have recently garnered a great deal of research interest: business models and the circular economy. This study focuses on both of them, and investigates circular business models. Not many studies have been conducted on this specific topic. Most of the studies focused on a particular type of circular business model, its specificity and context. Those models are related to various schools of thought underlying the concept of the circular economy, and they appear in the literature pertaining to sustainability, industrial ecology, cleaner production, and a closed-loop economy with different names. However, most of them can be reflected by the ReSOLVE framework developed by the Ellen MacArthur Foundation. The literature also indicated numerous adoption factors, design and managerial tools, and evaluation models needed for circular business models to operate.Regarding the design of circular business models, existing literature identified various circular business models, few business activities pertaining to the circular economy and some guidelines how to adapt existing business model to the circular economy. Yet, those studies were mostly case-based, and provided specific business models, but with limitations in their transferability. Although existing frameworks of business models can be used to apply the principles of the circular economy, hardly any study identified how the CE principles can be applied to each component of the business model framework. Hence, there is a need for a comprehensive conceptual framework for the circular business model to support practitioners in the transition of their businesses towards circular economy.
This paper addresses the issue of designing a circular business model from the perspective of every company. It identifies how the principles of the circular economy apply to a popular business model framework, and supplements this framework with additional components relevant to the circular economy. In turn, the circular business model canvas has been developed on the basis of the business model canvas. The CBMC consists of eleven building blocks, encompassing not only traditional components with minor modifications, but also material loops and adaptation factors. The triple fit challenge to implement a circular business model has been identified as a success factor. The provided framework should assist practitioners in designing circular business models; however, it requires further examination due to limitations of this study.
The conceptual framework of the circular business model proposed in this paper contributes to the discussion on implementation of the circular economy, and supports practitioners with a tool to accelerate the transition from linearity to circularity on a micro-level.
XXX . V0 A new tool for pricing used IT equipment
Introduction
The literature of Circuitism deals with two different subjects.[1] One subject is monetary theory, i.e. the functioning of the present-day money and banking system. The other subject focuses on the circulation of money. The Circuitist model examines how money originates in the banking sector by being credited to firms, circulates from the firms to wage earners, and flows back via the firms to the banking sector whereupon the money is extinguished.
Circuitism distances itself from neoclassical economics as well as from orthodox Keynesianism. Notwithstanding, Graziani makes positive reference to Keynes (but 'mostly the Treatise on Money, much less the General Theory'[2]) as well as to Kalecki and later representatives of Postkeynesianism (Moore, Minsky, Kregel, Davidson). He also acknowledges earlier contributions by the Swedish and German schools, e.g. Wicksell, Schumpeter and Hahn.
Circuitism is seen as a Postkeynesian theory, or an offspring of Postkeynesianism. This certainly applies to the monetary theory. The model of the money circuit, however, as will become apparent in the second part of this paper, looks rather like a new classical and Neomarxist construction of the money-mediated economic process dominated by banking capitalism. For the rest, the analytical perspective tends to be supply-side (from the firms' point of view) rather than Keynesian demand-side.
Under the angle of New Currency Theory as pursued on this website, there is agreement as well as partial disagreement with the monetary theory of Circuitism. With regard to the model of the money circuit, it appears as if that 'circuit' were just another case of over-simplified model-building.
Monetary theory
Under descriptive aspects the monetary theory of Circuitism reflects the state of knowledge of Postkeynesianism in recent decades. It builds on the notion of endogenous credit money in the form of deposits. Bank credit creates deposits, while the reverse, deposits serving to fund bank credit, does not hold true, except for formally independent investment units of banks such as investment trusts; these, however, are nonbank financial institutions.[3] Modern fiat money has no coverage by other monetary items. It is pure purchasing power in general and regular use.[4]
Circuitism has developed an explicit understanding of what it means to have a monetarised and financialised economy, in contrast to a mere barter economy, as is characteristic of neoclassical theories of market equilibria, that operates on 'exogenous' money and finances itself on the basis of recycled savings only. The money, or capital respectively, that pre-finances production and trade, however, is basically created as primary bank credit. Its existence, according to Circuitism, alters the structure and inner workings of the economy. In general, as Graziani says,
Graziani states on various occasions that central banks, as core institutions of the monetary system, must not be merged with 'the government' into one and the same category, i.e. the public sector, as opposed to the private and foreign sectors. Lumping together government and central bank creates confusion about monetary and fiscal functions and is bound to result in unreal ideas about the creation and circulation of money.
According to Circuitists, government has no role in creating money today, as 'the monetary base is being created by the banking system, and not as being the consequence of a government deficit'.[7] Whether this still is the case indirectly, remains open to question. The relevant aspect here is Graziani arguing in favour of a separation of monetary and fiscal functions, not to say separation of state powers between the government and the central bank. This is contrary to Keynes-inspired models of public-private sector balances, and the idea that government debt equals the creation of sovereign currency. This idea is to be found in the approach to sector balances by Godley/Lavoie, and more pointedly so in Modern Money Theory (MMT), another strand of Postkeynesian origin whose monetary theory otherwise overlaps with Circuitism in a number of aspects.[8]
Under descriptive aspects the monetary theory of Circuitism reflects the state of knowledge of Postkeynesianism in recent decades. It builds on the notion of endogenous credit money in the form of deposits. Bank credit creates deposits, while the reverse, deposits serving to fund bank credit, does not hold true, except for formally independent investment units of banks such as investment trusts; these, however, are nonbank financial institutions.[3] Modern fiat money has no coverage by other monetary items. It is pure purchasing power in general and regular use.[4]
Circuitism has developed an explicit understanding of what it means to have a monetarised and financialised economy, in contrast to a mere barter economy, as is characteristic of neoclassical theories of market equilibria, that operates on 'exogenous' money and finances itself on the basis of recycled savings only. The money, or capital respectively, that pre-finances production and trade, however, is basically created as primary bank credit. Its existence, according to Circuitism, alters the structure and inner workings of the economy. In general, as Graziani says,
'money is never neutral' and 'is, at the economic level, a source of profits and, at the social level, a source of power.' – 'Since access to money and credit is a key factor in a wage economy, producers of money and credit … enjoy a privileged position and are admitted as such to a share of total product.'[5]
According to Circuitist teaching, modern economies depend on how credit and money are managed. Likewise, the levels of employment and income are thought not to be determined by relative prices, but by the conditions of credit funding that are jointly decided upon by banks and firms, with the banks holding the whip hand. This stresses the Circuitists' view of 'the power of banks' and the overriding position of the banking industry as a pivotal player in the economy.[6]Graziani states on various occasions that central banks, as core institutions of the monetary system, must not be merged with 'the government' into one and the same category, i.e. the public sector, as opposed to the private and foreign sectors. Lumping together government and central bank creates confusion about monetary and fiscal functions and is bound to result in unreal ideas about the creation and circulation of money.
According to Circuitists, government has no role in creating money today, as 'the monetary base is being created by the banking system, and not as being the consequence of a government deficit'.[7] Whether this still is the case indirectly, remains open to question. The relevant aspect here is Graziani arguing in favour of a separation of monetary and fiscal functions, not to say separation of state powers between the government and the central bank. This is contrary to Keynes-inspired models of public-private sector balances, and the idea that government debt equals the creation of sovereign currency. This idea is to be found in the approach to sector balances by Godley/Lavoie, and more pointedly so in Modern Money Theory (MMT), another strand of Postkeynesian origin whose monetary theory otherwise overlaps with Circuitism in a number of aspects.[8]
Neglect of the dysfunctions of banks' primary credit creation
Despite the Circuitists' emphasis on the power of banks, and recognition of the bias towards privileged financial-capital revenue, there is, as is the case in Keynesianism in general, no criticism of the banking industry's systemic position as a monetary power. Circuitist theory seems to content itself with the description of the money and banking system, while being reluctant to evaluate the situation and give policy advice. Even if it could be read into some text passages that Circuitists may want to curb the power of banks, they have not, to my knowledge, contemplated reshaping the monetary and banking system.[9]
Still more remarkably from a New Currency point of view, Circuitists see no fault in fractional reserve banking and do not attribute financial instability and recurrent banking and financial crises to the regime of bank money such as it stands today. This is certainly typical for standard textbook economics and Keynesianism, but also for most scholars of Postkeynesianism, through to Circuitism and MMT. Quantities of money and GDP-disproportionate overshooting of pro-active primary credit and thus money creation are not an issue. This is a rare case of collective neglect of an issue – the quantity theory of money – that used to be a common topic for centuries. With special regard to Circuitism this also results from its version of the Banking-School's real bills doctrine as discussed below.
Despite the Circuitists' emphasis on the power of banks, and recognition of the bias towards privileged financial-capital revenue, there is, as is the case in Keynesianism in general, no criticism of the banking industry's systemic position as a monetary power. Circuitist theory seems to content itself with the description of the money and banking system, while being reluctant to evaluate the situation and give policy advice. Even if it could be read into some text passages that Circuitists may want to curb the power of banks, they have not, to my knowledge, contemplated reshaping the monetary and banking system.[9]
Still more remarkably from a New Currency point of view, Circuitists see no fault in fractional reserve banking and do not attribute financial instability and recurrent banking and financial crises to the regime of bank money such as it stands today. This is certainly typical for standard textbook economics and Keynesianism, but also for most scholars of Postkeynesianism, through to Circuitism and MMT. Quantities of money and GDP-disproportionate overshooting of pro-active primary credit and thus money creation are not an issue. This is a rare case of collective neglect of an issue – the quantity theory of money – that used to be a common topic for centuries. With special regard to Circuitism this also results from its version of the Banking-School's real bills doctrine as discussed below.
Ambiguity regarding the interplay between banks and central bank
In various passages Graziani is unclear, as Keynes was, as to whether banks or central banks have the lead in creating money. In both Keynes and Circuitism there seems to be a prevailing belief in the effectiveness of central-bank reserve positions and base rates for controlling, or at least influencing, the rate and pace of banks' credit creation. Graziani even seems to refer to the multiplier model (rightly given up in much of Postkeynesianism) when he explains that the Circuitist theory 'stresses the fact that the credit potential of the banking system depends on the monetary base, the reserve ratio'.[10]
On the other hand, Graziani endorses the banks' ability for pro-active primary credit creation, explicitly referring to Keynes's statement in the Treatise on Money that 'there is no limit to the amount of bank-money which the banks can safely create, provided that they move forward in step.' And, it has to be added, as long as central banks always accommodate the banks' demand for reserves.
On balance, Circuitism remains unclear about the question of who has the pro-active lead in creating money; unlike the accommodationist view of Postkeynesianism, to which there is no doubt that the banking industry has the lead in creating credit and deposits, while the central bank of a currency area reactively accommodates the banks' demand for fractional re-financing in the form of reserves and residual cash.[11] In consequence, primary bank credit determines the entire money supply. The creation of bank money certainly depends to a degree on the demand for money from firms, government and households. This, however, does not alter the position of the banks as the pivotal actors in the money supply chain, in that they decide selectively on whether, how much, for what and for whom they create primary credit, thus bank money.
In various passages Graziani is unclear, as Keynes was, as to whether banks or central banks have the lead in creating money. In both Keynes and Circuitism there seems to be a prevailing belief in the effectiveness of central-bank reserve positions and base rates for controlling, or at least influencing, the rate and pace of banks' credit creation. Graziani even seems to refer to the multiplier model (rightly given up in much of Postkeynesianism) when he explains that the Circuitist theory 'stresses the fact that the credit potential of the banking system depends on the monetary base, the reserve ratio'.[10]
On the other hand, Graziani endorses the banks' ability for pro-active primary credit creation, explicitly referring to Keynes's statement in the Treatise on Money that 'there is no limit to the amount of bank-money which the banks can safely create, provided that they move forward in step.' And, it has to be added, as long as central banks always accommodate the banks' demand for reserves.
On balance, Circuitism remains unclear about the question of who has the pro-active lead in creating money; unlike the accommodationist view of Postkeynesianism, to which there is no doubt that the banking industry has the lead in creating credit and deposits, while the central bank of a currency area reactively accommodates the banks' demand for fractional re-financing in the form of reserves and residual cash.[11] In consequence, primary bank credit determines the entire money supply. The creation of bank money certainly depends to a degree on the demand for money from firms, government and households. This, however, does not alter the position of the banks as the pivotal actors in the money supply chain, in that they decide selectively on whether, how much, for what and for whom they create primary credit, thus bank money.
Token money, paper money, and credit
There is another ambiguity when Graziani says that a monetary economy
Moreover, Graziani's 'nowadays' is now a long time ago. Depending on the country, paper money came into use in Europe around 1700 and became the predominant form of token money from about 1800 to the middle of the 20th century. However, throughout that time it never existed in its own right (except for a few short periods as colonial bills, continental dollars and Greenbacks in the history of the US).[13] Paper money was not constitutive for the monetary system, but rested on traditional silver and gold currency, or a central national reserve of gold bullion under the gold standard from 1844 to 1971, since then just on primary central-bank credit (= central-bank money = reserves).
At the source, modern money is non-cash money-on-account in a bank or central-bank account. Physical cash, as long as it remains in use, is exchanged out of and back into the basically non-cash money supply. For the time being this also holds true for e-cash. Whether e-cash, while physical cash is vanishing, will become another privileged domain of the banking industry that is ever more detaching itself from central banks and legal tender, or whether e-cash as legal tender will serve to restore the sovereign monetary prerogatives of the currency, money and seigniorage, this is being decided today in the further course of contemporary history.[14]
There is another ambiguity when Graziani says that a monetary economy
'must be using a token money, which is nowadays paper currency.' – 'Nowadays, money is paper money introduced into the market by means of bank credit'.[12]
This can be misunderstood. Bank credit creates deposits (bank money-on-account), not banknotes (paper money). As far as customers demand payout of deposits in cash, the banks need to obtain the coins and banknotes from the central bank, whereby the monopoly of coining rests with the national treasuries, while the central banks have the monopoly on banknotes since the 19th century. In contrast to bank money, the banks have to finance paper money and coins to 100%, not just fractionally. Moreover, Graziani's 'nowadays' is now a long time ago. Depending on the country, paper money came into use in Europe around 1700 and became the predominant form of token money from about 1800 to the middle of the 20th century. However, throughout that time it never existed in its own right (except for a few short periods as colonial bills, continental dollars and Greenbacks in the history of the US).[13] Paper money was not constitutive for the monetary system, but rested on traditional silver and gold currency, or a central national reserve of gold bullion under the gold standard from 1844 to 1971, since then just on primary central-bank credit (= central-bank money = reserves).
At the source, modern money is non-cash money-on-account in a bank or central-bank account. Physical cash, as long as it remains in use, is exchanged out of and back into the basically non-cash money supply. For the time being this also holds true for e-cash. Whether e-cash, while physical cash is vanishing, will become another privileged domain of the banking industry that is ever more detaching itself from central banks and legal tender, or whether e-cash as legal tender will serve to restore the sovereign monetary prerogatives of the currency, money and seigniorage, this is being decided today in the further course of contemporary history.[14]
Wrong identification of token money and credit money
A fundamental reason for not seeing problems with fractional reserve banking seems to be that teachings in Keynesian filiation identify token money with credit money, and take this as the unquestioned natural state of affairs. For once, though, Graziani makes a distinction between money and credit (as any Currency scholar will do), in that he declares money to be more than credit:
Beyond that passage, however, and much like Postkeynesianism and MMT, Graziani falls back to an absolute identification of money with credit, that is, token money with credit money, as an alleged historical fact and necessity from the archaic beginnings of civilisation. This ignores about 2,500 years of coin currencies where the rulers of a realm – the pre-modern State, in a sense – enjoyed the genuine seigniorage from minting coins and spending these into circulation free of debt; which of course can be done in much the same way and more easily with modern money-on-account and mobile e-cash. Credit money certainly is token money, but token money is not necessarily credit money.
A fundamental reason for not seeing problems with fractional reserve banking seems to be that teachings in Keynesian filiation identify token money with credit money, and take this as the unquestioned natural state of affairs. For once, though, Graziani makes a distinction between money and credit (as any Currency scholar will do), in that he declares money to be more than credit:
'something different from a regular commodity and something more than a mere promise of payment; ... money has to be accepted as a means of final settlement of the transaction, otherwise it would be credit and not money.'[15]
The observation that credit creates a mutual obligation to pay, whereas the transfer of money discharges an obligation to pay, captures an important aspect of the matter. Beyond that passage, however, and much like Postkeynesianism and MMT, Graziani falls back to an absolute identification of money with credit, that is, token money with credit money, as an alleged historical fact and necessity from the archaic beginnings of civilisation. This ignores about 2,500 years of coin currencies where the rulers of a realm – the pre-modern State, in a sense – enjoyed the genuine seigniorage from minting coins and spending these into circulation free of debt; which of course can be done in much the same way and more easily with modern money-on-account and mobile e-cash. Credit money certainly is token money, but token money is not necessarily credit money.
The rhetoric about endogenous and exogenous money
Postkeynesianism has developed the notion of endogenous and exogenous money, and holds the view that money (credit) in the modern economy is endogenous.[16] This can be endorsed, and yet may be misleading in a specific sense.
The distinction can be traced back to a narrative created by Adam Smith and lateron also Carl Menger in the 1870s (neoclassical Austrian School). According to this narrative, money is imagined to have emerged as a spontaneous creation in archaic barter and early market processes, originally as commodity money (livestock, grain, salt, silver), then coins made of silver, copper and gold, and more recently also as credit-based paper money originated by individual market participants. At the time of Smith and Menger, this idea was directed against money creation by alleged 'outsiders' to the economy, in particular political or religious authorities.
What is really known about archaic and traditional societies, however, provides evidence to the contrary. In the archaic beginnings, money was developed as a unit of account for documenting and clearing claims and obligations (debt, tributes). This took place in the extended household-economies of the worldly and religious rulers of the time and the related chains of provision. When coins were introduced much later, 2,700 years ago, coining was under the control of those rulers from the beginning.[17] The sequence of commodity monies > precious-metal coins > credit-based paper money is probably correct, not however the postulate of 'spontaneous' barter and market economies including the 'spontaneous' creation of money. Rather, the economy developed around the courts and temples of the rulers of a realm, under their control, including control of the monetary and financing practices at subsequent stages of development.
Seen in the light of historical knowledge and contemporary facts, it is not any economic agent who can create 'endogenous' credit or money. Today, only banks and national central banks, that is, monetary institutions, create money. (Treasury coins now count for less than 1 per cent of the money supply). Private currencies, such as not-for-profit complementary currencies or speculative bitcoins, and other private means of payment beyond bank money do exist, but are not used as a general and regular means of payment. Unlike bank money they are not official money, i.e. de facto authorised money in addition to legal tender. Also payment in kind, or the transfer of bills of exchange, debentures or other financial assets in lieu of payment in official money are special cases representing exemptions to the rule. With the development of electronic payment systems run by the central banks, payment in official money is the rule more than ever before.
In neoclassical and Keynesian mainstream economics from about the 1920s, the narrative of 'money from outside vs inside the economy' was specified – or say, re-interpreted – so as to label legal tender from the national central bank or the treasury as 'exogenous', whereas bank money is deemed 'endogenous'. This is reflected in the two-tier model of the banking system, which, more precisely, is a double-circuit money system comprising the public circulation based on bank money, and the interbank circulation based on central-bank money (reserves).
The split between the two also expresses the prevailing situation of incomplete chartalism.[18] This means there are nation-state currencies, while the money supply consists of state money and private bank money in parallel, with the bank money over time having come to dominate the entire system. The situation has not been questioned since the interwar period. There may be some controversy on whether money creation is led by the supply side or the demand side. But only Postkeynesianism, Circuitism and the New Currency perspective of the monetary reform movement have posed the question of the extent to which 'the power of banks' dominates the system and determines the creation of money.
The Postkeynesian notion of endogenous vs exogenous money is nonetheless fallacious. Banks and central banks both create credit money in basically the same way. Both of them do it on demand. The banks, however, apply selective supply policies of their own, including proprietary trading beyond customer demand. The central banks today, by contrast, deliver as much money as the banks are demanding. Presently, central banks no longer intend to exert control over the quantity of money. If bank money is seen as endogenous in the economy, so too must central-bank money. If central-bank money is seen as exogenous to the economy, so too must bank money.
Considering the status of bank money as endogenous and that of central-bank money as exogenous is purely arbitrary. It represents ideological labelling which makes banks appear as 'insiders' of the economy, whereas the central bank appears to be an alien outside agency, similar to the way in which many economists see the role of government. This still goes back to the bourgeois ideology of the market economy as an 'extra-territorial' Robinson island beyond the state and society, based on private law with no role for public or state law. Amid all the justified criticism of the feudal state and mercantilism of the 17th to the 19th centuries, the fundamental and indispensable role of the state in modern societies, including the money system and creating a legal framework for the economy and finances, was not properly understood; which often enough is still the case today.
Speaking of 'exogenous' money would only make sense if an amount of money would be given, somewhere from an elusive 'economic outside', prior to the economic process without dynamically changing with the demand for and the supply of money. Exogenous money in this sense, however, does not exist in a modern economy. If something that comes close to an exogenous money supply did ever exist, it was the silver and gold of traditional coin currencies, and―in concept, not in reality―national gold hoards under the old-industrial gold standard. Present-day fiat money, however, is always endogenous. In consequence, the distinction between exogenous and endogenous money is prejudiced and confusing.
A distinction analogous to endogenous vs exogenous and of the same meaning is the one between outside money (issued by the central bank and, maybe, the treasury) and inside money (issued by the banking industry).[19] The difference between the two wordings seems to be that 'outside money' is considered the more reliable, higher ranking asset in contrast to bank money, because 'outside money' comes from the central bank as the ultimate source of money and is also backed by the government, whereas banks in crisis are backed by no one―except their central bank and government. As a specification this is certainly correct. The terminology of inside vs outside nonetheless reproduces the ideological dictum according to which the banking industry is seen 'inside the markets' whereas the central banks are shunt off to an unreal, in fact non-existent position 'outside' the money and capital markets.
Postkeynesianism has developed the notion of endogenous and exogenous money, and holds the view that money (credit) in the modern economy is endogenous.[16] This can be endorsed, and yet may be misleading in a specific sense.
The distinction can be traced back to a narrative created by Adam Smith and lateron also Carl Menger in the 1870s (neoclassical Austrian School). According to this narrative, money is imagined to have emerged as a spontaneous creation in archaic barter and early market processes, originally as commodity money (livestock, grain, salt, silver), then coins made of silver, copper and gold, and more recently also as credit-based paper money originated by individual market participants. At the time of Smith and Menger, this idea was directed against money creation by alleged 'outsiders' to the economy, in particular political or religious authorities.
What is really known about archaic and traditional societies, however, provides evidence to the contrary. In the archaic beginnings, money was developed as a unit of account for documenting and clearing claims and obligations (debt, tributes). This took place in the extended household-economies of the worldly and religious rulers of the time and the related chains of provision. When coins were introduced much later, 2,700 years ago, coining was under the control of those rulers from the beginning.[17] The sequence of commodity monies > precious-metal coins > credit-based paper money is probably correct, not however the postulate of 'spontaneous' barter and market economies including the 'spontaneous' creation of money. Rather, the economy developed around the courts and temples of the rulers of a realm, under their control, including control of the monetary and financing practices at subsequent stages of development.
Seen in the light of historical knowledge and contemporary facts, it is not any economic agent who can create 'endogenous' credit or money. Today, only banks and national central banks, that is, monetary institutions, create money. (Treasury coins now count for less than 1 per cent of the money supply). Private currencies, such as not-for-profit complementary currencies or speculative bitcoins, and other private means of payment beyond bank money do exist, but are not used as a general and regular means of payment. Unlike bank money they are not official money, i.e. de facto authorised money in addition to legal tender. Also payment in kind, or the transfer of bills of exchange, debentures or other financial assets in lieu of payment in official money are special cases representing exemptions to the rule. With the development of electronic payment systems run by the central banks, payment in official money is the rule more than ever before.
In neoclassical and Keynesian mainstream economics from about the 1920s, the narrative of 'money from outside vs inside the economy' was specified – or say, re-interpreted – so as to label legal tender from the national central bank or the treasury as 'exogenous', whereas bank money is deemed 'endogenous'. This is reflected in the two-tier model of the banking system, which, more precisely, is a double-circuit money system comprising the public circulation based on bank money, and the interbank circulation based on central-bank money (reserves).
The split between the two also expresses the prevailing situation of incomplete chartalism.[18] This means there are nation-state currencies, while the money supply consists of state money and private bank money in parallel, with the bank money over time having come to dominate the entire system. The situation has not been questioned since the interwar period. There may be some controversy on whether money creation is led by the supply side or the demand side. But only Postkeynesianism, Circuitism and the New Currency perspective of the monetary reform movement have posed the question of the extent to which 'the power of banks' dominates the system and determines the creation of money.
The Postkeynesian notion of endogenous vs exogenous money is nonetheless fallacious. Banks and central banks both create credit money in basically the same way. Both of them do it on demand. The banks, however, apply selective supply policies of their own, including proprietary trading beyond customer demand. The central banks today, by contrast, deliver as much money as the banks are demanding. Presently, central banks no longer intend to exert control over the quantity of money. If bank money is seen as endogenous in the economy, so too must central-bank money. If central-bank money is seen as exogenous to the economy, so too must bank money.
Considering the status of bank money as endogenous and that of central-bank money as exogenous is purely arbitrary. It represents ideological labelling which makes banks appear as 'insiders' of the economy, whereas the central bank appears to be an alien outside agency, similar to the way in which many economists see the role of government. This still goes back to the bourgeois ideology of the market economy as an 'extra-territorial' Robinson island beyond the state and society, based on private law with no role for public or state law. Amid all the justified criticism of the feudal state and mercantilism of the 17th to the 19th centuries, the fundamental and indispensable role of the state in modern societies, including the money system and creating a legal framework for the economy and finances, was not properly understood; which often enough is still the case today.
Speaking of 'exogenous' money would only make sense if an amount of money would be given, somewhere from an elusive 'economic outside', prior to the economic process without dynamically changing with the demand for and the supply of money. Exogenous money in this sense, however, does not exist in a modern economy. If something that comes close to an exogenous money supply did ever exist, it was the silver and gold of traditional coin currencies, and―in concept, not in reality―national gold hoards under the old-industrial gold standard. Present-day fiat money, however, is always endogenous. In consequence, the distinction between exogenous and endogenous money is prejudiced and confusing.
A distinction analogous to endogenous vs exogenous and of the same meaning is the one between outside money (issued by the central bank and, maybe, the treasury) and inside money (issued by the banking industry).[19] The difference between the two wordings seems to be that 'outside money' is considered the more reliable, higher ranking asset in contrast to bank money, because 'outside money' comes from the central bank as the ultimate source of money and is also backed by the government, whereas banks in crisis are backed by no one―except their central bank and government. As a specification this is certainly correct. The terminology of inside vs outside nonetheless reproduces the ideological dictum according to which the banking industry is seen 'inside the markets' whereas the central banks are shunt off to an unreal, in fact non-existent position 'outside' the money and capital markets.
Incomplete picture of credit creation
The Circuitist view of the creation of bank money is incomplete in two ways. Firstly, there is too narrow a focus on bank loans; secondly, bank loans in the Circuitist model just flow to firms. The latter aspect is dealt with in the next chapter.
With regard to the first aspect, the Circuitist view misses the fact that banks create primary credit not only by way of making loans and granting overdraft, but equally by purchasing securities or real estate, and even by paying for salaries, services, equipment and materials. A payment from a bank to nonbanks creates deposits, while payments from nonbanks to a bank delete deposits.
In this respect, Graziani held a traditional view: 'A bank cannot buy commodities by means of its own credit (if it did so, it would require commodities from the market without giving anything in return).'[20] But of course, yes, banks can. They actually have to, because, since banks do not pay for salaries etc. in cash, they pay by crediting accounts, and when banks credit accounts they create primary bank credit and deposits. However, when banks receive payments from proprietary transactions in bank money, this creates an entry in the earnings account, while the deposits are deleted at the payer's bank and cease to exist.
More generally speaking, whenever a bank credits a giro account - held by nonbanks, nonbank financial intermediaries, or other banks apart from their central-bank account - new bank money is created, irrespective of the purpose of the transaction. Whenever payments are made to a bank from a giro account held by these actors, bank money is deleted.
How many excess reserves (payment reserves) a respective bank will ultimately obtain in the process, or will have to pay on balance, depends on the entirety of outgoing and incoming payments in both proprietary and customer transactions. In actual fact, the base of reserves involved in the process will be just a fraction of bank-money turnover at almost any point in time, even more so, the bigger a bank is (or a banking union with a central clearing unit).
Graziani obscures the matter further when saying that
There is, however, an important difference between two kinds of transactions. One is bank purchases of securities, foreign exchange, derivatives, real estate, gold, commodities, and long-term equipment. The other is expenditure on salaries, services and materials. The difference between the two is that the former types of transactions (securities, etc.) can be booked as an asset on the balance sheet, whereas the latter transactions (salaries, bonuses, services, operational costs) have to be booked as an expenditure à fonds perdu in the profit-and-loss account, with no additional asset as counterpart, thus one-sidedly debiting the equity. The final profit or loss of a bank, a surplus or deficit in its equity account, depends on the balance of its earnings and expenditures as well as on gains or losses in the value of its assets.
The Circuitist view of the creation of bank money is incomplete in two ways. Firstly, there is too narrow a focus on bank loans; secondly, bank loans in the Circuitist model just flow to firms. The latter aspect is dealt with in the next chapter.
With regard to the first aspect, the Circuitist view misses the fact that banks create primary credit not only by way of making loans and granting overdraft, but equally by purchasing securities or real estate, and even by paying for salaries, services, equipment and materials. A payment from a bank to nonbanks creates deposits, while payments from nonbanks to a bank delete deposits.
In this respect, Graziani held a traditional view: 'A bank cannot buy commodities by means of its own credit (if it did so, it would require commodities from the market without giving anything in return).'[20] But of course, yes, banks can. They actually have to, because, since banks do not pay for salaries etc. in cash, they pay by crediting accounts, and when banks credit accounts they create primary bank credit and deposits. However, when banks receive payments from proprietary transactions in bank money, this creates an entry in the earnings account, while the deposits are deleted at the payer's bank and cease to exist.
More generally speaking, whenever a bank credits a giro account - held by nonbanks, nonbank financial intermediaries, or other banks apart from their central-bank account - new bank money is created, irrespective of the purpose of the transaction. Whenever payments are made to a bank from a giro account held by these actors, bank money is deleted.
How many excess reserves (payment reserves) a respective bank will ultimately obtain in the process, or will have to pay on balance, depends on the entirety of outgoing and incoming payments in both proprietary and customer transactions. In actual fact, the base of reserves involved in the process will be just a fraction of bank-money turnover at almost any point in time, even more so, the bigger a bank is (or a banking union with a central clearing unit).
Graziani obscures the matter further when saying that
'banks need to make use of interest payments made by firms in order to pay wages and salaries to their employees, buy commodities on the market, and possibly pay interest on deposits.'[21]
Interest payments to a bank, however, cannot 'be used' by that bank for making subsequent payments. Banks certainly need to keep up a certain balance of incoming and outgoing reserves (in order to avoid costly liquidity shortages). It does not make a difference, however, where the reserves come from, from proprietary or customer transactions, and whether a bank has enough reserves available when a payment has to be carried out, or whether the reserves have to be taken up, upon payment or afterwards, from the central bank or in the interbank market. In any case, banks do not need to have received a particular amount in interest payments in order to be able to pay salaries or purchase securities. There is, however, an important difference between two kinds of transactions. One is bank purchases of securities, foreign exchange, derivatives, real estate, gold, commodities, and long-term equipment. The other is expenditure on salaries, services and materials. The difference between the two is that the former types of transactions (securities, etc.) can be booked as an asset on the balance sheet, whereas the latter transactions (salaries, bonuses, services, operational costs) have to be booked as an expenditure à fonds perdu in the profit-and-loss account, with no additional asset as counterpart, thus one-sidedly debiting the equity. The final profit or loss of a bank, a surplus or deficit in its equity account, depends on the balance of its earnings and expenditures as well as on gains or losses in the value of its assets.
The model of the money circuit
The Circuitists' model of money circulation consists of a four-step sequence from money creation to its deletion: banks credit firms > firms pay employees > employees buy what firms produce > firms pay back the credit to the banks.[22] According to Graziani, 'Circuit theory tries to consider the whole life cycle of money, starting with its creation by means of bank loans and ending with its destruction when these loans are repaid.'[23]
In actual fact, however, the Circuitist model does not satisfy the claim of representing 'the whole life cycle of money'. Beyond the bank-firm-relationship, the model does not make a distinction between real-economic and financial transactions, in particular non-GDP-related transactions; it does not systematically differentiate between banks and financial intermediaries; it reproduces the old-industrial concept of production and consumption; equally, it reproduces the old-industrial concept of capital and labour; it blinds out the interdependencies with foreign economies; equally, it blinds out the fundamental economic role of the state; it thereby also reproduces the lopsided idea of 'primary' allocation and distribution by the private economy, and 'secondary' redistribution by the government.
The Circuitists' model of money circulation consists of a four-step sequence from money creation to its deletion: banks credit firms > firms pay employees > employees buy what firms produce > firms pay back the credit to the banks.[22] According to Graziani, 'Circuit theory tries to consider the whole life cycle of money, starting with its creation by means of bank loans and ending with its destruction when these loans are repaid.'[23]
In actual fact, however, the Circuitist model does not satisfy the claim of representing 'the whole life cycle of money'. Beyond the bank-firm-relationship, the model does not make a distinction between real-economic and financial transactions, in particular non-GDP-related transactions; it does not systematically differentiate between banks and financial intermediaries; it reproduces the old-industrial concept of production and consumption; equally, it reproduces the old-industrial concept of capital and labour; it blinds out the interdependencies with foreign economies; equally, it blinds out the fundamental economic role of the state; it thereby also reproduces the lopsided idea of 'primary' allocation and distribution by the private economy, and 'secondary' redistribution by the government.
Old-industrial logic of capital vs labour
What firms sell to and buy from other firms is blanked out in the model on the grounds that this affects payments among firms, i.e. trade within the same 'sector', where expenditures and earnings are netting out. The model thus considers banks, firms and wage earners as the three sectors of the economy, in methodological analogy to other Keynesian sector-account mechanics (which, though, are based on different types of sectors, i.e. a private, public, and foreign sector). According to the three sectors of the Circuitist model, 'real output gets divided into real wages, industrial profits, and financial profits'.[24]
Circuitism defines the economy as a wage economy. This is not the only aspect under which the model is reminiscent of 19th century theories of division of labour (forerunners of today's life-cycle and chain analyses) and, in particular, theories of labour value according to which all value added can be retraced to labour employed, which is to say, wages paid. In Marxism this also includes wages foregone to the workers due to appropriation by the capitalist entrepreneurs and bankers.
The model thus reproduces the old-industrial logic of capital and labour. This certainly continues to be a defining component, and yet it is too simplistic in order to capture realities in a sufficiently differentiated way. For example, earned income must not be reduced to dependent wage labour, while it continues to be inappropriate to merge income earned by self-employed and small and medium-sized businesses with 'industrial capital'.
Equally, real-economic and financial investment is absolutely fundamental to modern economies, as Circuitism recognises by its definition of what a 'money economy' is. It thus is flawed to give capital revenues as such a negative connotation. Even if it does not apply to the lower classes, many dependent employees today have, to a degree, savings and other invested funds and thus benefit from capital revenue. Moreover, in today's individualised society, 'non-active' individuals represent about half of the population. They have to be supplied with money, but can no longer simply be treated as the family appendage of the wage earners and recipients of capital income.
What firms sell to and buy from other firms is blanked out in the model on the grounds that this affects payments among firms, i.e. trade within the same 'sector', where expenditures and earnings are netting out. The model thus considers banks, firms and wage earners as the three sectors of the economy, in methodological analogy to other Keynesian sector-account mechanics (which, though, are based on different types of sectors, i.e. a private, public, and foreign sector). According to the three sectors of the Circuitist model, 'real output gets divided into real wages, industrial profits, and financial profits'.[24]
Circuitism defines the economy as a wage economy. This is not the only aspect under which the model is reminiscent of 19th century theories of division of labour (forerunners of today's life-cycle and chain analyses) and, in particular, theories of labour value according to which all value added can be retraced to labour employed, which is to say, wages paid. In Marxism this also includes wages foregone to the workers due to appropriation by the capitalist entrepreneurs and bankers.
The model thus reproduces the old-industrial logic of capital and labour. This certainly continues to be a defining component, and yet it is too simplistic in order to capture realities in a sufficiently differentiated way. For example, earned income must not be reduced to dependent wage labour, while it continues to be inappropriate to merge income earned by self-employed and small and medium-sized businesses with 'industrial capital'.
Equally, real-economic and financial investment is absolutely fundamental to modern economies, as Circuitism recognises by its definition of what a 'money economy' is. It thus is flawed to give capital revenues as such a negative connotation. Even if it does not apply to the lower classes, many dependent employees today have, to a degree, savings and other invested funds and thus benefit from capital revenue. Moreover, in today's individualised society, 'non-active' individuals represent about half of the population. They have to be supplied with money, but can no longer simply be treated as the family appendage of the wage earners and recipients of capital income.
Banks and nonbank financial institutions
In Circuitism – and not only there – the term 'bank' is not used consistently. In many passages 'bank' properly means a commercial monetary institutions that creates primary credit and deposits, refinances itself at the central bank if need be, and participates in the electronic payment system of the central bank. In other passages, however, the term 'bank' is also used for nonbank financial intermediaries that help to on-lend or to invest already existing bank money. Sometimes 'bank' is used as a generic term for both types of financial firms.
The difference between banks and intermediaries is that only banks are monetary institutions that create and delete bank money (deposits), whereby they do not on-lend or invest existing deposits. Financial intermediaries, by contrast, are not able to create deposits. They are no monetary institutions. They operate as managers and investors of already existing deposits.
The difference between banks as monetary institutions and nonbank financial intermediaries must not be blurred. When loans or bonds are redeemed to a nonbank creditor, the money involved is not deleted, but continues to circulate. At the same time, the banks continue to create additional credit (deposits) if this is in their individual business interest. Over time this can lead to problematic effects, as discussed at the end of this paper.
In Circuitism – and not only there – the term 'bank' is not used consistently. In many passages 'bank' properly means a commercial monetary institutions that creates primary credit and deposits, refinances itself at the central bank if need be, and participates in the electronic payment system of the central bank. In other passages, however, the term 'bank' is also used for nonbank financial intermediaries that help to on-lend or to invest already existing bank money. Sometimes 'bank' is used as a generic term for both types of financial firms.
The difference between banks and intermediaries is that only banks are monetary institutions that create and delete bank money (deposits), whereby they do not on-lend or invest existing deposits. Financial intermediaries, by contrast, are not able to create deposits. They are no monetary institutions. They operate as managers and investors of already existing deposits.
The difference between banks as monetary institutions and nonbank financial intermediaries must not be blurred. When loans or bonds are redeemed to a nonbank creditor, the money involved is not deleted, but continues to circulate. At the same time, the banks continue to create additional credit (deposits) if this is in their individual business interest. Over time this can lead to problematic effects, as discussed at the end of this paper.
The real-bills doctrine of Circuitism
The Circuitist model comes with its implicit version of the real bills doctrine. This was a central Banking-School position in the historical controversy with the Currency School. The doctrine maintains that banks will always create an optimum quantity of money, neither an inflationary overshoot nor a deflationary shortage of the money supply, and will thus always operate on the safe side as long as they create money for funding 'real bills', i.e. credit against bills of exchange or other securities issued by reputable enterprises, sound business, etc. Moreover, if banks do so, they should do it over the short rather than the long term. In the face of the realities of banking and entrepreneurship, this is just glossing things over, including a good measure of pretence of knowledge. In the end, as things naturally turn out, firms and banks often have not had enough knowledge, or things may change in an unforeseen way, so that initial expectations ascribed to projects and 'real bills' become unreal. What is more, many bankers, investors and adventurers, particularly in the upswing and climax of business and financial cycles, cannot stop themselves from leveraging up the stakes.
Such market dynamics and related risk behaviour are no issue in Circuitism, as the existence of a huge non-GDP-related financial economy is non-existent in the Circuitist model. Instead, primary and secondary credit are assumed to fund real-economic expenditure of firms only. In this respect, the Circuitists' understanding of the financial economy is under-developed. In particular, it fails to see the difference between GDP-related and non GDP-related transactions – a flaw which again is typical not only for Circuitism. The growth of non GDP-related finance has been particularly important since around 1980, but it already existed in the beginnings of Circuitism.
In the Circuitist model, firms and banks are supposed to make appropriate predictions regarding business perspectives, the demand for what they intend to supply, future prices, the work force, etc. Firms are supposed to know how much money they will need, and they negotiate the credit conditions with the banks for funding the firms' planned activities. The firms' demand for money thus is supposed to have a 'real' and reliable foundation, and banks accordingly cannot fail in serving that demand – in fact another real bills doctrine, all the more, as banks in the last decades have created primary credit predominantly for financial investment, including real-estate bubbles, and for sovereign-bond bubbles by financing governments far beyond reasonable levels of indebtedness.
The Circuitist model comes with its implicit version of the real bills doctrine. This was a central Banking-School position in the historical controversy with the Currency School. The doctrine maintains that banks will always create an optimum quantity of money, neither an inflationary overshoot nor a deflationary shortage of the money supply, and will thus always operate on the safe side as long as they create money for funding 'real bills', i.e. credit against bills of exchange or other securities issued by reputable enterprises, sound business, etc. Moreover, if banks do so, they should do it over the short rather than the long term. In the face of the realities of banking and entrepreneurship, this is just glossing things over, including a good measure of pretence of knowledge. In the end, as things naturally turn out, firms and banks often have not had enough knowledge, or things may change in an unforeseen way, so that initial expectations ascribed to projects and 'real bills' become unreal. What is more, many bankers, investors and adventurers, particularly in the upswing and climax of business and financial cycles, cannot stop themselves from leveraging up the stakes.
Such market dynamics and related risk behaviour are no issue in Circuitism, as the existence of a huge non-GDP-related financial economy is non-existent in the Circuitist model. Instead, primary and secondary credit are assumed to fund real-economic expenditure of firms only. In this respect, the Circuitists' understanding of the financial economy is under-developed. In particular, it fails to see the difference between GDP-related and non GDP-related transactions – a flaw which again is typical not only for Circuitism. The growth of non GDP-related finance has been particularly important since around 1980, but it already existed in the beginnings of Circuitism.
In the Circuitist model, firms and banks are supposed to make appropriate predictions regarding business perspectives, the demand for what they intend to supply, future prices, the work force, etc. Firms are supposed to know how much money they will need, and they negotiate the credit conditions with the banks for funding the firms' planned activities. The firms' demand for money thus is supposed to have a 'real' and reliable foundation, and banks accordingly cannot fail in serving that demand – in fact another real bills doctrine, all the more, as banks in the last decades have created primary credit predominantly for financial investment, including real-estate bubbles, and for sovereign-bond bubbles by financing governments far beyond reasonable levels of indebtedness.
Is there a necessary sequence in money circulation?
The Circuitist model states a specific sequence in the circulation of money. Developing some such sequence, as an alternative to older classical and neoclassical positions, was among Keynes's research desiderata. Among those older models was the distinction between basic industries, or capital-goods industries, and consumer-goods industries (economic sections I and II in Marxist economics), as well as the Austrian-School five- to seven-step production model that is underlying its capital theory.[25]
The centrepiece of the Circuitist model is bank credit to firms.
This is overly reductionist. The Circuitist model does not correspond to the empirical pattern of present-day credit and money creation. The 'circuit' represents just one component in a wider picture. Close to 60% of bank lending today is allotted to mortgages. The rest is spread over government debt, student loans (in the US), consumer credit (overdraft, car, credit-card and home-equity-line credit) as well as lending to firms.[28] The latter, of course, continues to be part of the banking business, but is in no way predominant and applies to small and medium-sized enterprises rather than big companies. Industrial corporations no longer depend on bank credit to a major extent. They tap the secondary credit market, i.e. on-lending of already existing bank money, for example, by way of issuing corporate bonds, shares, or taking up money from investment funds. Moreover, large multinationals now run banks of their own (which is a questionable development in terms of separation of monetary, fiscal, financial and real-economic functions).
In recent decades, furthermore, liquid bank money (i.e. money circulating by way of primary and secondary credit, as represented in European M1) has grown several times the nominal GDP that represents the economic product at current prices (including consumer price inflation). This is to say that the lion's share of credit went into financial non-GDP transactions, into self-referential and quite often purely speculative financial portfolio trading. The disproportionate growth of such non-GDP transactions creates bubbles so that even mortgages and sovereign bonds, normally considered as conservative investments, can turn into high-risk exposures.
According to classical and neoclassical views, credit should first flow into capital expenditure, especially into private investment in productive capacities, not immediately into consumption, and less so into government expenditure, both of which are supposed to result in inflation. In the beginning of industrialisation, with productive capacities at a low level of development, and potential consumptive demand still unsatisfied for the most part, the idea of 'investment in productive capacities first, consumption second' made some sense.
Programs of government expenditure since the 1930s, in particular Keynesian demand-side policies after WWII, established a complementary alternative to the classical attitude. In the context of a structurally entrenched lack of effective demand, additional government expenditure and increased wages were ascribed a positive role of their own, because this prevents deflationary depression and, as long as capacities are underused, does not entail an important risk of inflation. One reason is that productive capacities today are much higher and connected through global markets. This means that supply chains are flexibly adaptive. Increased demand for goods and services triggers a swift increase in supply rather than inflation, the more so as long as the cost level in new industrial and developing countries is much lower than in developed countries.
This is not to justify the abuse of Keynesian demand-side policies by permanent deficit spending as a bad political all-seasons habit detached from the real business cycle, resulting in all-too high levels of government expenditure and debt. In many cases, moreover, state interventionism actually contributes to reinforcing rather than overcoming problems of structural entrenchment.
Circuitism does not contribute to analysing such questions. Its narrow focus on 'banks financing firms' in fact leaves a somewhat dated impression. Classical, Marxist and neoclassical economists until the 1920s used to think in these terms, including R. Hilferding's and R. Luxemburg's notion of financial capitalism as banking capitalism. During the century since, the arena of actors and the complexity of the financial and real economy have considerably evolved. Focussing questions of money and finance too narrowly on the firm now represents an old-industrial bias of economics that may have had a point from around 1800 until about the 1960s. One consequence of this has been building the industrial welfare state too narrowly upon the relationship between employers and wage labour. Over time this has become another fiscal and financial-market problem without lastingly solving respective social problems.
A positive aspect in the model is that Circuitists reject a special focus on investment in real-economic capacities. They rather refer to 'the monetary cost of output in general', i.e. capital expenditure with a broad meaning, including wages.
Notwithstanding, the firms in the Circuitist model still stand for the production of consumer supplies, the wage earners for the effective demand which absorbs the consumer goods and household-related services supplied. Again, this is just one part of the whole picture. It reproduces, however, the concept of a linear vertical production chain of an economy entirely aimed at 'final' private consumption. This is reflected in today's national accounts and the Circuitist model which describes the economy a reduced linear circle from the creation of bank money for financing the production of goods by firms, which includes paying wages, to wage-earning consumers buying consumer items and household-related services, so that firms are able to pay back the credit, plus interest, to the banks. This may be handy, and, as is known, Henry Ford thought this way a hundred years ago. Today, it does not sufficiently reflect the multifaceted realities of the economy, less so the financial economy and the total picture of the circulation of money.
The real-economic supply-side channel is of course an important one, but there is a wider picture – supply-side and demand-side impulses; by firms, private households and public units; life cycles of technologies, products/services and markets as well as vertical and horizontal chains of provision; including the arbitrariness of classifying steps therein as 'productive/investive' or 'consumptive'; the existence of a GDP-related and non-GDP money circulation. All this suggests the development of a more complex understanding of what money circulation actually encompasses.
It follows from this that there is no 'natural' sequence in the circulation of money. Instead, there can be various ways of channelling new money into circulation, and many ways in the further circulation of the money. There is no such thing as a strictly necessary sequence regarding the creation, circulation and deletion of money. Respective doctrines can safely be dropped. The important thing is that enough money for GDP-related purposes can be obtained by financial institutions, firms, private households and public bodies whenever they need it.
The above criticism of the circuitist model is certainly of a relative nature. Even if outmoded to a degree, the model maintains a core of truth which is certainly more adequate than, for example, the Postkeynesian model of sector balances which confuses its sectoral book-keeping model of the economy with an analysis of monetary and financial dynamics.
The Circuitist model states a specific sequence in the circulation of money. Developing some such sequence, as an alternative to older classical and neoclassical positions, was among Keynes's research desiderata. Among those older models was the distinction between basic industries, or capital-goods industries, and consumer-goods industries (economic sections I and II in Marxist economics), as well as the Austrian-School five- to seven-step production model that is underlying its capital theory.[25]
The centrepiece of the Circuitist model is bank credit to firms.
Fontana: 'Money ... is mainly the flow of bank deposits demanded by firms to finance the production of goods and services'.[26]
Graziani: 'Negotiations between banks and firms on the money market determine the amount of credit actually granted and the rate of interest charged to firms. ... The model is money market first, labour market second, the first determining the conditions for the latter. ... The total amount of money is a debt of the firms to the banking sector and a credit of wage-earners to the same sector'.[27]
Circuitists certainly do not ignore credit to other actor groups, such as consumer credit, mortgages, or sovereign bonds. Rather, they consider these segments of the banking and financial business to be of secondary importance, implicitly maintaining that everything is determined by the gravitational circuit between capital (banks and firms) and labour (wage earners).This is overly reductionist. The Circuitist model does not correspond to the empirical pattern of present-day credit and money creation. The 'circuit' represents just one component in a wider picture. Close to 60% of bank lending today is allotted to mortgages. The rest is spread over government debt, student loans (in the US), consumer credit (overdraft, car, credit-card and home-equity-line credit) as well as lending to firms.[28] The latter, of course, continues to be part of the banking business, but is in no way predominant and applies to small and medium-sized enterprises rather than big companies. Industrial corporations no longer depend on bank credit to a major extent. They tap the secondary credit market, i.e. on-lending of already existing bank money, for example, by way of issuing corporate bonds, shares, or taking up money from investment funds. Moreover, large multinationals now run banks of their own (which is a questionable development in terms of separation of monetary, fiscal, financial and real-economic functions).
In recent decades, furthermore, liquid bank money (i.e. money circulating by way of primary and secondary credit, as represented in European M1) has grown several times the nominal GDP that represents the economic product at current prices (including consumer price inflation). This is to say that the lion's share of credit went into financial non-GDP transactions, into self-referential and quite often purely speculative financial portfolio trading. The disproportionate growth of such non-GDP transactions creates bubbles so that even mortgages and sovereign bonds, normally considered as conservative investments, can turn into high-risk exposures.
According to classical and neoclassical views, credit should first flow into capital expenditure, especially into private investment in productive capacities, not immediately into consumption, and less so into government expenditure, both of which are supposed to result in inflation. In the beginning of industrialisation, with productive capacities at a low level of development, and potential consumptive demand still unsatisfied for the most part, the idea of 'investment in productive capacities first, consumption second' made some sense.
Programs of government expenditure since the 1930s, in particular Keynesian demand-side policies after WWII, established a complementary alternative to the classical attitude. In the context of a structurally entrenched lack of effective demand, additional government expenditure and increased wages were ascribed a positive role of their own, because this prevents deflationary depression and, as long as capacities are underused, does not entail an important risk of inflation. One reason is that productive capacities today are much higher and connected through global markets. This means that supply chains are flexibly adaptive. Increased demand for goods and services triggers a swift increase in supply rather than inflation, the more so as long as the cost level in new industrial and developing countries is much lower than in developed countries.
This is not to justify the abuse of Keynesian demand-side policies by permanent deficit spending as a bad political all-seasons habit detached from the real business cycle, resulting in all-too high levels of government expenditure and debt. In many cases, moreover, state interventionism actually contributes to reinforcing rather than overcoming problems of structural entrenchment.
Circuitism does not contribute to analysing such questions. Its narrow focus on 'banks financing firms' in fact leaves a somewhat dated impression. Classical, Marxist and neoclassical economists until the 1920s used to think in these terms, including R. Hilferding's and R. Luxemburg's notion of financial capitalism as banking capitalism. During the century since, the arena of actors and the complexity of the financial and real economy have considerably evolved. Focussing questions of money and finance too narrowly on the firm now represents an old-industrial bias of economics that may have had a point from around 1800 until about the 1960s. One consequence of this has been building the industrial welfare state too narrowly upon the relationship between employers and wage labour. Over time this has become another fiscal and financial-market problem without lastingly solving respective social problems.
A positive aspect in the model is that Circuitists reject a special focus on investment in real-economic capacities. They rather refer to 'the monetary cost of output in general', i.e. capital expenditure with a broad meaning, including wages.
Notwithstanding, the firms in the Circuitist model still stand for the production of consumer supplies, the wage earners for the effective demand which absorbs the consumer goods and household-related services supplied. Again, this is just one part of the whole picture. It reproduces, however, the concept of a linear vertical production chain of an economy entirely aimed at 'final' private consumption. This is reflected in today's national accounts and the Circuitist model which describes the economy a reduced linear circle from the creation of bank money for financing the production of goods by firms, which includes paying wages, to wage-earning consumers buying consumer items and household-related services, so that firms are able to pay back the credit, plus interest, to the banks. This may be handy, and, as is known, Henry Ford thought this way a hundred years ago. Today, it does not sufficiently reflect the multifaceted realities of the economy, less so the financial economy and the total picture of the circulation of money.
The real-economic supply-side channel is of course an important one, but there is a wider picture – supply-side and demand-side impulses; by firms, private households and public units; life cycles of technologies, products/services and markets as well as vertical and horizontal chains of provision; including the arbitrariness of classifying steps therein as 'productive/investive' or 'consumptive'; the existence of a GDP-related and non-GDP money circulation. All this suggests the development of a more complex understanding of what money circulation actually encompasses.
It follows from this that there is no 'natural' sequence in the circulation of money. Instead, there can be various ways of channelling new money into circulation, and many ways in the further circulation of the money. There is no such thing as a strictly necessary sequence regarding the creation, circulation and deletion of money. Respective doctrines can safely be dropped. The important thing is that enough money for GDP-related purposes can be obtained by financial institutions, firms, private households and public bodies whenever they need it.
The above criticism of the circuitist model is certainly of a relative nature. Even if outmoded to a degree, the model maintains a core of truth which is certainly more adequate than, for example, the Postkeynesian model of sector balances which confuses its sectoral book-keeping model of the economy with an analysis of monetary and financial dynamics.
Classical bias regarding the 'secondary' economic status of the state
The Circuitist model reproduces the classical view regarding allocation through enterprises, followed by primary distribution between capital and labour, and secondary redistribution by way of taxes through the state.[30] This too has been taken as the natural state of affairs up to the present day. It is a common feature in almost all approaches to economic modelling. Economic models often start from a version without the state (and no foreign economy), and then proceed to less-simplified versions including the state (and possibly a foreign economy). What nevertheless remains is the coding of the 'economic base' as primary/productive/ entrepreneurial/competitive, and the 'state superstructure' as secondary/unproductive/bureaucratic/power-dominated/monopolist, or in the same vein.
Once more the real picture is different, and a rather mixed one on both fronts. In modern corporate economies, private-sector companies tend to be heavily bureaucratised; most markets – not only labour, but also goods and services as well as certain segments in finance – are power-dominated and oligopolistic; factor allocation is often inefficient.
Regarding the relationship between the 'economic base' and the 'state superstructure' one cannot really say in the ongoing process which is the chicken and which is the egg. With the government sector representing 35–60% of GDP, and with much of the additions to the money supply created due to government demand for additional money, the government's economic status is anything but secondary. In actual and historical fact, the state represents the institutional, legal and infrastructural base of the economy which includes private as much as public firms, institutes, organisations and households. Seen like this, the state would appear as the 'primary basis' rather than a secondary redistributive 'superstructure' (which is not advocated here). Marx and Engels' utopia of communism was somewhat grotesque when they expected the dwindling-away of the state (an element of early 19th century social romanticism, at the time present in liberalism as much as lateron in both anarchism and socialism).
Government expenditure is certainly not always optimal, but so too is private capital expenditure. Labelling government expenditure per se as 'unproductive' and private capital expenditure as 'productive' is ideological humbug. Government expenditure feeds mass purchasing power more effectively than capital expenditure does by itself. Government provides necessary administrative and judicial functions, also and specifically for the economy. Government provides general infrastructures and a wide range of public services, including health and education, the biggest sectors of the economy. How much of this is to be classified as consumptive or investive, and how much contributes to 'reproducing' or 'producing' human capital, is a highly arbitrary and futile question, comparable to the flawed 19th century theories of productive and unproductive labour. In the transition from traditional to modern societies, all of these questions are backward-looking to pre- and old-industrial stages of development.
The Circuitist model reproduces the classical view regarding allocation through enterprises, followed by primary distribution between capital and labour, and secondary redistribution by way of taxes through the state.[30] This too has been taken as the natural state of affairs up to the present day. It is a common feature in almost all approaches to economic modelling. Economic models often start from a version without the state (and no foreign economy), and then proceed to less-simplified versions including the state (and possibly a foreign economy). What nevertheless remains is the coding of the 'economic base' as primary/productive/ entrepreneurial/competitive, and the 'state superstructure' as secondary/unproductive/bureaucratic/power-dominated/monopolist, or in the same vein.
Once more the real picture is different, and a rather mixed one on both fronts. In modern corporate economies, private-sector companies tend to be heavily bureaucratised; most markets – not only labour, but also goods and services as well as certain segments in finance – are power-dominated and oligopolistic; factor allocation is often inefficient.
Regarding the relationship between the 'economic base' and the 'state superstructure' one cannot really say in the ongoing process which is the chicken and which is the egg. With the government sector representing 35–60% of GDP, and with much of the additions to the money supply created due to government demand for additional money, the government's economic status is anything but secondary. In actual and historical fact, the state represents the institutional, legal and infrastructural base of the economy which includes private as much as public firms, institutes, organisations and households. Seen like this, the state would appear as the 'primary basis' rather than a secondary redistributive 'superstructure' (which is not advocated here). Marx and Engels' utopia of communism was somewhat grotesque when they expected the dwindling-away of the state (an element of early 19th century social romanticism, at the time present in liberalism as much as lateron in both anarchism and socialism).
Government expenditure is certainly not always optimal, but so too is private capital expenditure. Labelling government expenditure per se as 'unproductive' and private capital expenditure as 'productive' is ideological humbug. Government expenditure feeds mass purchasing power more effectively than capital expenditure does by itself. Government provides necessary administrative and judicial functions, also and specifically for the economy. Government provides general infrastructures and a wide range of public services, including health and education, the biggest sectors of the economy. How much of this is to be classified as consumptive or investive, and how much contributes to 'reproducing' or 'producing' human capital, is a highly arbitrary and futile question, comparable to the flawed 19th century theories of productive and unproductive labour. In the transition from traditional to modern societies, all of these questions are backward-looking to pre- and old-industrial stages of development.
Lost in the circuit
The model of the money circuit raises yet another old issue, that is, the 'loss' of a certain quantity of money in circulation, because money owners may retain some part of their money rather than spending it or lending it to others who spend it.
Much in this context, however, rather than holding liquidity, is about avoiding liquidity and debt, or reducing them, respectively. Banks systematically avoid holding more liquidity than is necessary in order to make current payments. The actual question here is whether banks—as primary credit creators—are prepared to lend or invest, supposing there are potential debtors who appear to be creditworthy and are prepared to go into debt. Avoidance of currently not necessitated liquidity also applies to nonbank financial intermediaries, real-economic firms and public households in a similar way.
Private households, too, do not hoard large quantities of cash under the mattress, and normally there is not much idle money in current bank accounts either. Rather, money which is currently not needed is parked as a savings or time deposit in M2/M3, about 10–20% of income in advanced countries.
What is actually relevant with regard to the thesis of a 'loss in the circuit', is the fact that M2/M3-positions are non-liquid, even though they can be liquidated within a couple of weeks or months. (If there are M2-positions which can be liquidated any time, these are mis-classified positions which actually belong in M1). M2/M3-positions in fact represent a reduction in liquid money M1. M2/M3-positions, contrary to popular belief, do not serve to fund loans or investment. Credits in a savings or time account with a bank represent inactivated, non-circulating bank money.
It would nevertheless be inadequate to interpret M2/M3-items as 'hoarded currency'. Rather, M2/M3 is part of the equity of those households, beneficial to the entire economy, particularly in a life-time or other long-range perspective. With endogenous money, the banking industry—or whoever else exercises the privileged prerogative of creating money—can fill any supposed gap in M1.
Liquidity preference is certainly real. It causes a need for maturity transformation, or tolerated maturity mismatch, respectively. Equally, liquidity preference represents pro-cyclical behaviour. It waxes and wanes in the rhythm of economic and financial cycles. However, it does not cause cycles and crises by itself. Should there really be a 'Circuitist' problem with regard to absorbing what the firms have produced, this has not necessarily to do with liquidity preference and liquidity shortage. Nor is it, under present-day conditions, a fundamental problem when firms have to borrow additional money in order to finance current business. The central role ascribed to liquidity preference in Keynesian and Postkeynesian economics is overdone.
As an alternative to M2/M3-savings, money can be invested in sovereign and corporate bonds, stocks, and funds of various types. This represents secondary credit which keeps the bank money circulating in M1, thus preventing it from being 'lost' in the circuit. The question remains, nonetheless, whether the money is lost to the real economy. The secondarily on-lent or invested part of the money supply can serve to fund real expenditure of firms, government and consumers (as is the case, for example, with IPOs of bonds and stocks). But the money may also go into non-GDP transactions (such as after-IPO trading of securities as well as mergers and acquisitions, hostile takeovers, or speculative investment in foreign exchange, real estate, commodities and derivatives).
In a way, the 'loss' in the money circuit and the supposed liquidity gap resulting from it, is an analogy to another question that has haunted theologists and social philosophers for centuries, i.e. the interest gap, the question of how, with a given money supply, to pay interest on top of repaying the principal. Circuitism is preoccupied with its version of a liquidity gap, while not looking into the question of an interest gap. Discussing the latter might anyway be going too far here. But I would like to remark that problems such as the Circuitist liquidity gap, or the Anarchosyndicalist interest gap, represent methodological artefacts resulting from the reductionist nature of the respective model considerations.
Is it not simply the case that in a monetarised and financialised economy, all kinds of expenditure, or income respectively, must initially and perpetually be funded to a considerable extent? And that with endogenous money there is basically no reason why this should not be ensured? Things would be different with exogenous money, but that is not part of our reality. Whether things may somewhat be different in a post-growth economy remains to be seen.
The model of the money circuit raises yet another old issue, that is, the 'loss' of a certain quantity of money in circulation, because money owners may retain some part of their money rather than spending it or lending it to others who spend it.
Graziani: 'If wage earners decide to keep part of their savings in the form of liquid balances … firms will get back from the markets less money than they have initially injected in it … there has been a loss in the circuit.[31]
Fontana: 'Circuitists have explained that for any given production process an increase in money holdings by wage earners is exactly the same as a loss of liquidity, and hence an equivalent increase in bank debts by firms.'[32]
In a way this is right, but reminiscent of the notion of hoarding of money in traditional economies. Graziani actually uses the term hoarding for that part of savings that are not on-lent or invested by wage earners on the secondary credit market.[33] The subject was treated in Keynes as the problem of liquidity preference.Much in this context, however, rather than holding liquidity, is about avoiding liquidity and debt, or reducing them, respectively. Banks systematically avoid holding more liquidity than is necessary in order to make current payments. The actual question here is whether banks—as primary credit creators—are prepared to lend or invest, supposing there are potential debtors who appear to be creditworthy and are prepared to go into debt. Avoidance of currently not necessitated liquidity also applies to nonbank financial intermediaries, real-economic firms and public households in a similar way.
Private households, too, do not hoard large quantities of cash under the mattress, and normally there is not much idle money in current bank accounts either. Rather, money which is currently not needed is parked as a savings or time deposit in M2/M3, about 10–20% of income in advanced countries.
What is actually relevant with regard to the thesis of a 'loss in the circuit', is the fact that M2/M3-positions are non-liquid, even though they can be liquidated within a couple of weeks or months. (If there are M2-positions which can be liquidated any time, these are mis-classified positions which actually belong in M1). M2/M3-positions in fact represent a reduction in liquid money M1. M2/M3-positions, contrary to popular belief, do not serve to fund loans or investment. Credits in a savings or time account with a bank represent inactivated, non-circulating bank money.
It would nevertheless be inadequate to interpret M2/M3-items as 'hoarded currency'. Rather, M2/M3 is part of the equity of those households, beneficial to the entire economy, particularly in a life-time or other long-range perspective. With endogenous money, the banking industry—or whoever else exercises the privileged prerogative of creating money—can fill any supposed gap in M1.
Liquidity preference is certainly real. It causes a need for maturity transformation, or tolerated maturity mismatch, respectively. Equally, liquidity preference represents pro-cyclical behaviour. It waxes and wanes in the rhythm of economic and financial cycles. However, it does not cause cycles and crises by itself. Should there really be a 'Circuitist' problem with regard to absorbing what the firms have produced, this has not necessarily to do with liquidity preference and liquidity shortage. Nor is it, under present-day conditions, a fundamental problem when firms have to borrow additional money in order to finance current business. The central role ascribed to liquidity preference in Keynesian and Postkeynesian economics is overdone.
As an alternative to M2/M3-savings, money can be invested in sovereign and corporate bonds, stocks, and funds of various types. This represents secondary credit which keeps the bank money circulating in M1, thus preventing it from being 'lost' in the circuit. The question remains, nonetheless, whether the money is lost to the real economy. The secondarily on-lent or invested part of the money supply can serve to fund real expenditure of firms, government and consumers (as is the case, for example, with IPOs of bonds and stocks). But the money may also go into non-GDP transactions (such as after-IPO trading of securities as well as mergers and acquisitions, hostile takeovers, or speculative investment in foreign exchange, real estate, commodities and derivatives).
In a way, the 'loss' in the money circuit and the supposed liquidity gap resulting from it, is an analogy to another question that has haunted theologists and social philosophers for centuries, i.e. the interest gap, the question of how, with a given money supply, to pay interest on top of repaying the principal. Circuitism is preoccupied with its version of a liquidity gap, while not looking into the question of an interest gap. Discussing the latter might anyway be going too far here. But I would like to remark that problems such as the Circuitist liquidity gap, or the Anarchosyndicalist interest gap, represent methodological artefacts resulting from the reductionist nature of the respective model considerations.
Is it not simply the case that in a monetarised and financialised economy, all kinds of expenditure, or income respectively, must initially and perpetually be funded to a considerable extent? And that with endogenous money there is basically no reason why this should not be ensured? Things would be different with exogenous money, but that is not part of our reality. Whether things may somewhat be different in a post-growth economy remains to be seen.
XXX . V00 E-Commerce and E-Business/Concepts and Definitions
What is e-commerce?
Electronic commerce or e-commerce refers to a wide range of online business activities for products and services. [1] It also pertains to “any form of business transaction in which the parties interact electronically rather than by physical exchanges or direct physical contact.” [2]E-commerce is usually associated with buying and selling over the Internet, or conducting any transaction involving the transfer of ownership or rights to use goods or services through a computer-mediated network. [3] Though popular, this definition is not comprehensive enough to capture recent developments in this new and revolutionary business phenomenon. A more complete definition is: E-commerce is the use of electronic communications and digital information processing technology in business transactions to create, transform, and redefine relationships for value creation between or among organizations, and between organizations and individuals. [4]
International Data Corp (IDC) estimates the value of global e-commerce in 2000 at US$350.38 billion. This is projected to climb to as high as US$3.14 trillion by 2004. IDC also predicts an increase in Asia’s percentage share in worldwide e-commerce revenue from 5% in 2000 to 10% in 2004 (See Figure 1).
Figure 1: Worldwide E-Commerce Revenue, 2000 and 2004 (as a % share of each country/region)
 |
Asia-Pacific e-commerce revenues are projected to increase from $76.8 billion at year-end of 2001 to $338.5 billion by the end of 2004.
Is e-commerce the same as e-business?
While some use e-commerce and e-business interchangeably, they are distinct concepts. In e-commerce, information and communications technology (ICT) is used in inter-business or inter-organizational transactions (transactions between and among firms/organizations) and in business-to-consumer transactions (transactions between firms/organizations and individuals).
In e-business, on the other hand, ICT is used to enhance one’s business. It includes any process that a business organization (either a for-profit, governmental or non-profit entity) conducts over a computer-mediated network. A more comprehensive definition of e-business is:
- “The transformation of an organization’s processes to deliver additional customer value through the application of technologies, philosophies and computing paradigm of the new economy.”
1. Production processes, which include procurement, ordering and replenishment of stocks; processing of payments; electronic links with suppliers; and production control processes, among others;
2. Customer-focused processes, which include promotional and marketing efforts, selling over the Internet, processing of customers’ purchase orders and payments, and customer support, among others; and
3. Internal management processes, which include employee services, training, internal information-sharing, video-conferencing, and recruiting. Electronic applications enhance information flow between production and sales forces to improve sales force productivity. Workgroup communications and electronic publishing of internal business information are likewise made more efficient. [6]
Is the Internet economy synonymous with e-commerce and e-business?
The Internet economy is a broader concept than e-commerce and e-business. It includes e-commerce and e-business.The CREC (Center for Research in Electronic Commerce) at the University of Texas has developed a conceptual framework for how the Internet economy works. The framework shows four layers of the Internet economy-the three mentioned above and a fourth called intermediaries (see Table 1).
Figure 2. Table 1. Internet Economy Conceptual Frame
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What are the different types of e-commerce?
The major different kinds of e-commerce are: business-to-business (B2B); business-to-consumer (B2C); business-to-government (B2G); consumer-to-consumer (C2C); and mobile commerce (m-commerce).
What is B2B e-commerce?B2B e-commerce is simply defined as e-commerce between companies. This is the type of e-commerce that deals with relationships between and among businesses. About 80% of e-commerce is of this type, and most experts predict that B2B e-commerce will continue to grow faster than the B2C segment. The B2B market has two primary components: e-frastructure and e-markets. E-frastructure is the architecture of B2B, primarily consisting of the following:
- logistics - transportation, warehousing and distribution (e.g., Procter and Gamble);
- application service providers - deployment, hosting and management of packaged software from a central facility (e.g., Oracle and Linkshare);
- outsourcing of functions in the process of e-commerce, such as Web-hosting, security and customer care solutions (e.g., outsourcing providers such as eShare, NetSales, iXL Enterprises and Universal Access);
- auction solutions software for the operation and maintenance of real-time auctions in the Internet (e.g., Moai Technologies and OpenSite Technologies);
- content management software for the facilitation of Web site content management and delivery (e.g., Interwoven and ProcureNet); and
- Web-based commerce enablers (e.g., Commerce One, a browser-based, XML-enabled purchasing automation software).
The more common B2B examples and best practice models are IBM, Hewlett Packard (HP), Cisco and Dell. Cisco, for instance, receives over 90% of its product orders over the Internet.
Most B2B applications are in the areas of supplier management (especially purchase order processing), inventory management (i.e., managing order-ship-bill cycles), distribution management (especially in the transmission of shipping documents), channel management (i.e., information dissemination on changes in operational conditions), and payment management (e.g., electronic payment systems or EPS).11
eMarketer projects an increase in the share of B2B e-commerce in total global e-commerce from 79.2% in 2000 to 87% in 2004 and a consequent decrease in the share of B2C e-commerce from 20.8% in 2000 to only 13% in 2004 (Figure 3).
Figure 3. Share of B2B and B2C E-Commerce in Total Global E-Commerce (2000 and 2004)
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Likewise B2B growth is way ahead of B2C growth in the Asia-Pacific region. According to a 2001 eMarketer estimate, B2B revenues in the region are expected to exceed $300 billion by 2004.
Table 2 shows the projected size of B2B e-commerce by region for the years 2000-2004.
Figure 4. Projected B2B E-Commerce by Region, 2000-2004 ($billions)
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- Box 1. Benefits of B2B E-Commerce in Developing Markets
The impact of B2B markets on the economy of developing countries is evident in the following:
Transaction costs. There are three cost areas that are significantly reduced through the conduct of B2B e-commerce. First is the reduction of search costs, as buyers need not go through multiple intermediaries to search for information about suppliers, products and prices as in a traditional supply chain. In terms of effort, time and money spent, the Internet is a more efficient information channel than its traditional counterpart. In B2B markets, buyers and sellers are gathered together into a single online trading community, reducing search costs even further. Second is the reduction in the costs of processing transactions (e.g. invoices, purchase orders and payment schemes), as B2B allows for the automation of transaction processes and therefore, the quick implementation of the same compared to other channels (such as the telephone and fax). Efficiency in trading processes and transactions is also enhanced through the B2B e-market’s ability to process sales through online auctions. Third, online processing improves inventory management and logistics.
Disintermediation. Through B2B e-markets, suppliers are able to interact and transact directly with buyers, thereby eliminating intermediaries and distributors. However, new forms of intermediaries are emerging. For instance, e-markets themselves can be considered as intermediaries because they come between suppliers and customers in the supply chain.
Transparency in pricing.Among the more evident benefits of e-markets is the increase in price transparency. The gathering of a large number of buyers and sellers in a single e-market reveals market price information and transaction processing to participants. The Internet allows for the publication of information on a single purchase or transaction, making the information readily accessible and available to all members of the e-market. Increased price transparency has the effect of pulling down price differentials in the market. In this context, buyers are provided much more time to compare prices and make better buying decisions. Moreover, B2B e-markets expand borders for dynamic and negotiated pricing wherein multiple buyers and sellers collectively participate in price-setting and two-way auctions. In such environments, prices can be set through automatic matching of bids and offers. In the e-marketplace, the requirements of both buyers and sellers are thus aggregated to reach competitive prices, which are lower than those resulting from individual actions.
Economies of scale and network effects. The rapid growth of B2B e-markets creates traditional supply-side cost-based economies of scale. Furthermore, the bringing together of a significant number of buyers and sellers provides the demand-side economies of scale or network effects. Each additional incremental participant in the e-market creates value for all participants in the demand side. More participants form a critical mass, which is key in attracting more users to an e-market.
Transaction costs. There are three cost areas that are significantly reduced through the conduct of B2B e-commerce. First is the reduction of search costs, as buyers need not go through multiple intermediaries to search for information about suppliers, products and prices as in a traditional supply chain. In terms of effort, time and money spent, the Internet is a more efficient information channel than its traditional counterpart. In B2B markets, buyers and sellers are gathered together into a single online trading community, reducing search costs even further. Second is the reduction in the costs of processing transactions (e.g. invoices, purchase orders and payment schemes), as B2B allows for the automation of transaction processes and therefore, the quick implementation of the same compared to other channels (such as the telephone and fax). Efficiency in trading processes and transactions is also enhanced through the B2B e-market’s ability to process sales through online auctions. Third, online processing improves inventory management and logistics.
Disintermediation. Through B2B e-markets, suppliers are able to interact and transact directly with buyers, thereby eliminating intermediaries and distributors. However, new forms of intermediaries are emerging. For instance, e-markets themselves can be considered as intermediaries because they come between suppliers and customers in the supply chain.
Transparency in pricing.Among the more evident benefits of e-markets is the increase in price transparency. The gathering of a large number of buyers and sellers in a single e-market reveals market price information and transaction processing to participants. The Internet allows for the publication of information on a single purchase or transaction, making the information readily accessible and available to all members of the e-market. Increased price transparency has the effect of pulling down price differentials in the market. In this context, buyers are provided much more time to compare prices and make better buying decisions. Moreover, B2B e-markets expand borders for dynamic and negotiated pricing wherein multiple buyers and sellers collectively participate in price-setting and two-way auctions. In such environments, prices can be set through automatic matching of bids and offers. In the e-marketplace, the requirements of both buyers and sellers are thus aggregated to reach competitive prices, which are lower than those resulting from individual actions.
Economies of scale and network effects. The rapid growth of B2B e-markets creates traditional supply-side cost-based economies of scale. Furthermore, the bringing together of a significant number of buyers and sellers provides the demand-side economies of scale or network effects. Each additional incremental participant in the e-market creates value for all participants in the demand side. More participants form a critical mass, which is key in attracting more users to an e-market.
Business-to-consumer e-commerce, or commerce between companies and consumers, involves customers gathering information; purchasing physical goods (i.e., tangibles such as books or consumer products) or information goods (or goods of electronic material or digitized content, such as software, or e-books); and, for information goods, receiving products over an electronic network.12
It is the second largest and the earliest form of e-commerce. Its origins can be traced to online retailing (or e-tailing).13 Thus, the more common B2C business models are the online retailing companies such as Amazon.com, Drugstore.com, Beyond.com, Barnes and Noble and ToysRus. Other B2C examples involving information goods are E-Trade and Travelocity.
The more common applications of this type of e-commerce are in the areas of purchasing products and information, and personal finance management, which pertains to the management of personal investments and finances with the use of online banking tools (e.g., Quicken).14
eMarketer estimates that worldwide B2C e-commerce revenues will increase from US$59.7 billion in 2000 to US$428.1 billion by 2004. Online retailing transactions make up a significant share of this market. eMarketer also estimates that in the Asia-Pacific region, B2C revenues, while registering a modest figure compared to B2B, nonetheless went up to $8.2 billion by the end of 2001, with that figure doubling at the end of 2002-at total worldwide B2C sales below 10%.
B2C e-commerce reduces transactions costs (particularly search costs) by increasing consumer access to information and allowing consumers to find the most competitive price for a product or service. B2C e-commerce also reduces market entry barriers since the cost of putting up and maintaining a Web site is much cheaper than installing a “brick-and-mortar” structure for a firm. In the case of information goods, B2C e-commerce is even more attractive because it saves firms from factoring in the additional cost of a physical distribution network. Moreover, for countries with a growing and robust Internet population, delivering information goods becomes increasingly feasible.
What is B2G e-commerce?
Business-to-government e-commerce or B2G is generally defined as commerce between companies and the public sector. It refers to the use of the Internet for public procurement, licensing procedures, and other government-related operations. This kind of e-commerce has two features: first, the public sector assumes a pilot/leading role in establishing e-commerce; and second, it is assumed that the public sector has the greatest need for making its procurement system more effective.15
Web-based purchasing policies increase the transparency of the procurement process (and reduces the risk of irregularities). To date, however, the size of the B2G e-commerce market as a component of total e-commerce is insignificant, as government e-procurement systems remain undeveloped.
What is C2C e-commerce?
Consumer-to-consumer e-commerce or C2C is simply commerce between private individuals or consumers.
This type of e-commerce is characterized by the growth of electronic marketplaces and online auctions, particularly in vertical industries where firms/businesses can bid for what they want from among multiple suppliers.16 It perhaps has the greatest potential for developing new markets.
This type of e-commerce comes in at least three forms:
- auctions facilitated at a portal, such as eBay, which allows online real-time bidding on items being sold in the Web;
- peer-to-peer systems, such as the Napster model (a protocol for sharing files between users used by chat forums similar to IRC) and other file exchange and later money exchange models; and
- classified ads at portal sites such as Excite Classifieds and eWanted , Pakwheels.com (an interactive, online marketplace where buyers and sellers can negotiate and which features “Buyer Leads & Want Ads”).
There is little information on the relative size of global C2C e-commerce. However, C2C figures of popular C2C sites such as eBay and Napster indicate that this market is quite large. These sites produce millions of dollars in sales every day.
Advantages of C2C sites
Consumer to consumer e-commerce has many benefits. The primary benefit to consumers is reduction in cost. Buying ad space on other e-commerce sites is expensive. Sellers can post their items for free or with minimal charge depending on the C2C website. C2C websites form a perfect platform for buyers and sellers who wish to buy and sell related products. The ability to find related products leads to an increase in the visitor to customer conversion ratio. Business owners can cheaply maintain C2C websites and increase profits without the additional costs of distribution locations. A good example of a C2C e-commerce website is Esty, a site that allows consumers to buy and sell handmade or vintage items and supplies including art, photography, clothing, jewelry, food, bath and beauty products, quilts, knick-knacks, and toys.
Disadvantages of C2C sites
There are a couple of disadvantages to these type of sites as well.Doing transaction on these type of websites requires co-operation between the buyer and seller.It has been noted many times that these two do not co-operate with each other after a transaction has been made.They do not share the transaction information which may be via credit or debit card or internet banking.This can result in online fraud since the buyer and seller are not very well versed with each other.This can lead to lawsuit being imposed on either ends or also on the site if it has not mentioned the disclaimer in it’s terms and conditions.This may also hamper the c2c website's reputation.Companies which handle consumer to consumer ecommerce websites seem to have becoming very cautious to prevent online scams.
What is m-commerce?
M-commerce (mobile commerce) is the buying and selling of goods and services through wireless technology-i.e., handheld devices such as cellular telephones and personal digital assistants (PDAs). Japan is seen as a global leader in m-commerce.
As content delivery over wireless devices becomes faster, more secure, and scalable, some believe that m-commerce will surpass wireline e-commerce as the method of choice for digital commerce transactions. This may well be true for the Asia-Pacific where there are more mobile phone users than there are Internet users.
Industries affected by m-commerce include:
- Financial services, including mobile banking (when customers use their handheld devices to access their accounts and pay their bills), as well as brokerage services (in which stock quotes can be displayed and trading conducted from the same handheld device);
- Telecommunications, in which service changes, bill payment and account reviews can all be conducted from the same handheld device;
- Service/retail, as consumers are given the ability to place and pay for orders on-the-fly; and
- Information services, which include the delivery of entertainment, financial news, sports figures and traffic updates to a single mobile device.17
Figure 5. Table 3. Forrester’s M-Commerce Sales Predictions, 2001-2005
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What forces are fueling e-commerce?
There are at least three major forces fueling e-commerce: economic forces, marketing and customer interaction forces, and technology, particularly multimedia convergence.18Economic forces.One of the most evident benefits of e-commerce is economic efficiency resulting from the reduction in communications costs, low-cost technological infrastructure, speedier and more economic electronic transactions with suppliers, lower global information sharing and advertising costs, and cheaper customer service alternatives.
Economic integration is either external or internal. External integration refers to the electronic networking of corporations, suppliers, customers/clients, and independent contractors into one community communicating in a virtual environment (with the Internet as medium). Internal integration, on the other hand, is the networking of the various departments within a corporation, and of business operations and processes. This allows critical business information to be stored in a digital form that can be retrieved instantly and transmitted electronically. Internal integration is best exemplified by corporate intranets. Among the companies with efficient corporate intranets are Procter and Gamble, IBM, Nestle and Intel.
- Box 2. SESAMi.NET.: Linking Asian Markets through B2B Hubs
SESAMi.NET is Asia’s largest B2B e-hub, a virtual exchange integrating and connecting businesses (small, medium or large) to trading partners, e-marketplaces and internal enterprise systems for the purpose of sourcing out supplies, buying and selling goods and services online in real time. The e-hub serves as the center for management of content and the processing of business transactions with support services such as financial clearance and information services.
It is strategically and dynamically linked to the Global Trading Web (GTW), the world’s largest network of trading communities on the Internet. Because of this very important link, SESAMi reaches an extensive network of regional, vertical and industry-specific interoperable B2B e-markets across the globe.
It is strategically and dynamically linked to the Global Trading Web (GTW), the world’s largest network of trading communities on the Internet. Because of this very important link, SESAMi reaches an extensive network of regional, vertical and industry-specific interoperable B2B e-markets across the globe.
- Box 3. Brazil’s Submarino19: Improving Customer Service through the Internet
Brazil’s Submarino is a classic example of successful use of the Internet for improved customer service and support. From being a local Sao Paulo B2C e-commerce company selling books, CDs, video cassettes, DVDs, toys, electronic and computer products in Brazil, it expanded to become the largest company of its kind in Argentina, Mexico, Spain and Portugal. Close to a third of the 1.4 million Internet users in Brazil have made purchases through this site. To enhance customer service, Submarino has diversified into offering logistical and technological infrastructure to other retailers, which includes experience and expertise in credit analysis, tracking orders and product comparison systems.
Moreover, the principle of universal access can be made more achievable with convergence. At present the high costs of installing landlines in sparsely populated rural areas is a disincentive to telecommunications companies to install telephones in these areas. Installing landlines in rural areas can become more attractive to the private sector if revenues from these landlines are not limited to local and long distance telephone charges, but also include cable TV and Internet charges. This development will ensure affordable access to information even by those in rural areas and will spare the government the trouble and cost of installing expensive landlines.21
What are the components of a typical successful e-commerce transaction loop?
E-commerce does not refer merely to a firm putting up a Web site for the purpose of selling goods to buyers over the Internet. For e-commerce to be a competitive alternative to traditional commercial transactions and for a firm to maximize the benefits of e-commerce, a number of technical as well as enabling issues have to be considered. A typical e-commerce transaction loop involves the following major players and corresponding requisites:The Seller should have the following components:
- A corporate Web site with e-commerce capabilities (e.g., a secure transaction server);
- A corporate intranet so that orders are processed in an efficient manner; and
- IT-literate employees to manage the information flows and maintain the e-commerce system.
- Banking institutions that offer transaction clearing services (e.g., processing credit card payments and electronic fund transfers);
- National and international freight companies to enable the movement of physical goods within, around and out of the country. For business-to-consumer transactions, the system must offer a means for cost-efficient transport of small packages (such that purchasing books over the Internet, for example, is not prohibitively more expensive than buying from a local store); and
- Authentication authority that serves as a trusted third party to ensure the integrity and security of transactions.
- Form a critical mass of the population with access to the Internet and disposable income enabling widespread use of credit cards; and
- Possess a mindset for purchasing goods over the Internet rather than by physically inspecting items.
Government, to establish:
- A legal framework governing e-commerce transactions (including electronic documents, signatures, and the like); and
- Legal institutions that would enforce the legal framework (i.e., laws and regulations) and protect consumers and businesses from fraud, among others.
- A robust and reliable Internet infrastructure; and
- A pricing structure that doesn’t penalize consumers for spending time on and buying goods over the Internet (e.g., a flat monthly charge for both ISP access and local phone calls).
How is the Internet relevant to e-commerce?
The Internet allows people from all over the world to get connected inexpensively and reliably. As a technical infrastructure, it is a global collection of networks, connected to share information using a common set of protocols. Also, as a vast network of people and information, the Internet is an enabler for e-commerce as it allows businesses to showcase and sell their products and services online and gives potential customers, prospects, and business partners access to information about these businesses and their products and services that would lead to purchase.Before the Internet was utilized for commercial purposes, companies used private networks-such as the EDI or Electronic Data Interchange-to transact business with each other. That was the early form of e-commerce. However, installing and maintaining private networks was very expensive. With the Internet, e-commerce spread rapidly because of the lower costs involved and because the Internet is based on open standards.25
How important is an intranet for a business engaging in e-commerce?
An intranet aids in the management of internal corporate information that may be interconnected with a company’s e-commerce transactions (or transactions conducted outside the intranet). Inasmuch as the intranet allows for the instantaneous flow of internal information, vital information is simultaneously processed and matched with data flowing from external e-commerce transactions, allowing for the efficient and effective integration of the corporation’s organizational processes. In this context, corporate functions, decisions and processes involving e-commerce activities are more coherent and organized.The proliferation of intranets has caused a shift from a hierarchical command-and-control organization to an information-based organization. This shift has implications for managerial responsibilities, communication and information flows, and workgroup structures.
Aside from reducing the cost of doing business, what are the advantages of e-commerce for businesses?
E-commerce serves as an “equalizer”. It enables start-up and small- and medium-sized enterprises to reach the global market.- Box 4. Leveling the Playing Field through E-commerce: The Case of Amazon.com
Amazon.com is a virtual bookstore. It does not have a single square foot of bricks and mortar retail floor space. Nonetheless, Amazon.com is posting an annual sales rate of approximately $1.2 billion, equal to about 235 Barnes & Noble (B&N) superstores. Due to the efficiencies of selling over the Web, Amazon has spent only $56 million on fixed assets, while B&N has spent about $118 million for 235 superstores. (To be fair, Amazon has yet to turn a profit, but this does not obviate the point that in many industries doing business through e-commerce is cheaper than conducting business in a traditional brick-and-mortar company.)
- Box 5. Lessons from the Dot Com Frenzy
According to Webmergers.com statistics, about 862 dot-com companies have failed since the height of the dot-com bust in January 2000. Majority of these were e-commerce and content companies. The shutdown of these companies was followed by the folding up of Internet-content providers, infrastructure companies, Internet service providers, and other providers of dial-up and broadband Internet-access services.26
From the perspective of the investment banks, the dot-com frenzy can be likened to a gamble where the big money players were the venture capitalists and those laying their bets on the table were the small investors. The bust was primarily caused by the players’ unfamiliarity with the sector, coupled with failure to cope with the speed of the Internet revolution and the amount of capital in circulation.27
Internet entrepreneurs set the prices of their goods and services at very low levels to gain market share and attract venture capitalists to infuse funding. The crash began when investors started demanding hard earnings for sky-high valuations. The Internet companies also spent too much on overhead before even gaining a market share.28
From the perspective of the investment banks, the dot-com frenzy can be likened to a gamble where the big money players were the venture capitalists and those laying their bets on the table were the small investors. The bust was primarily caused by the players’ unfamiliarity with the sector, coupled with failure to cope with the speed of the Internet revolution and the amount of capital in circulation.27
Internet entrepreneurs set the prices of their goods and services at very low levels to gain market share and attract venture capitalists to infuse funding. The crash began when investors started demanding hard earnings for sky-high valuations. The Internet companies also spent too much on overhead before even gaining a market share.28
E-commerce allows “network production.” This refers to the parceling out of the production process to contractors who are geographically dispersed but who are connected to each other via computer networks. The benefits of network production include: reduction in costs, more strategic target marketing, and the facilitation of selling add-on products, services, and new systems when they are needed. With network production, a company can assign tasks within its non-core competencies to factories all over the world that specialize in such tasks (e.g., the assembly of specific components).
How is e-commerce helpful to the consumer?
In C2B transactions, customers/consumers are given more influence over what and how products are made and how services are delivered, thereby broadening consumer choices. E-commerce allows for a faster and more open process, with customers having greater control.E-commerce makes information on products and the market as a whole readily available and accessible, and increases price transparency, which enable customers to make more appropriate purchasing decisions.
How are business relationships transformed through e-commerce?
E-commerce transforms old economy relationships (vertical/linear relationships) to new economy relationships characterized by end-to-end relationship management solutions (integrated or extended relationships).How does e-commerce link customers, workers, suppliers, distributors and competitors?
E-commerce facilitates organization networks, wherein small firms depend on “partner” firms for supplies and product distribution to address customer demands more effectively.To manage the chain of networks linking customers, workers, suppliers, distributors, and even competitors, an integrated or extended supply chain management solution is needed. Supply chain management (SCM) is defined as the supervision of materials, information, and finances as they move from supplier to manufacturer to wholesaler to retailer to consumer. It involves the coordination and integration of these flows both within and among companies. The goal of any effective supply chain management system is timely provision of goods or services to the next link in the chain (and ultimately, the reduction of inventory within each link).29
There are three main flows in SCM, namely:
- The product flow, which includes the movement of goods from a supplier to a customer, as well as any customer returns or service needs;
- The information flow, which involves the transmission of orders and the update of the status of delivery; and
- The finances flow, which consists of credit terms, payment schedules, and consignment and title ownership arrangements.
Figure 6. Old Economy Relationships vs. New Economy Relationships
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What is Google AdSense and how does it work for e-commerce
Google AdSense is a service offered by Google that allows website publishers to advertise on Google. It is Google's number 1 source of revenue. AdSense is used to advertise when users type in key words in Google's search engine. Ads are placed on the right hand side of the screen. The ads are text based and allow for links to the website on the advertisement as well.The AdWords program determines the pricing for key words. AdWords is based on a Vickrey auction system. It is a sealed-bid auction, users submit bids not knowing what other users bid. The highest bidder wins but the second place person's bid is paid. There are pros and cons to this type of auction. The winners the vast majority of the time are the ones who bid the highest. A downside to this type of system is that there is no price discovery, which is a market failure known as imperfect information.
AdSense users generate revenue by having users click on their links and by having them buy what is offered on their website. AdSense has been a huge success for Google and the users of the system.
XXX . V000 POSSIBLE ECONOMIC CONSEQUENCE OF DIGITAL CASH
Digital cash brings benefits as well as problems. One major advantage of digital cash is its increased efficiency opening new opportunities, especially for small businesses. On the other hand, it will encourage potentially the worsening of problems over taxation and money laundering. In turn, these problems may alter foreign exchange rates, disturb money supplies, and encourage an overall financial crisis.The transnationality of digital cash - the ability of digital cash to flow freely across national borders - encourages these benefits and problems, and could have significant repercussions internationally.
From an economic view, this transnationality is the most important characteristic of digital cash. If digital cash behaved like traditional currencies, circulating within a national border and controlled by a central monetary authority, there would be few economic implications that would be worth analyzing. In this scenario, digital cash would be nothing more than a convenient transaction method such as a credit card.However, digital cash's very transnationality has the potential to cause conflict between cyberspace and nation states. If digital cash spreads successfully in the next century, its history may be written as a transcript of economic battles between nation states.
What are the economic consequences of digital cash? What are its implications from the view of economics? In recent years, several proposals for electronic cash have appeared in cyberspace. In several cases, forms of digital cash are already in use [1]. The economic consequences of these transactions have not yet been fully examined.
To some observers, one important economic consequence of electronic cash is the free issue of private currency by commercial banks or other non-firms [2]. However, if we look at the history of money, it is not easy to make privately issued currency credible in the eyes and wallets of the public. As long as there is competition between banks, private banks will sometimes become bankrupt. Nothing is more debilitating to the credibility of privately issued currency than bankruptcy.The most important characteristic of digital cash is its transnationality. Digital cash does not recognize national borders. It is not controlled by any central bank of any nation state. The unprecedented efficiency of international payments with digital cash may indeed increase the instability of the global monetary system. This efficiency indeed may lead to conflicts between digital cash providers and users and the central banks of nation states.
There are over a dozen proposals for electronic payment systems on the Internet [3]. To briefly understand these systems, let's us examine a few issues by trying to pay a bill via the Internet with a credit card. In comparison to using cash in the real world, transmitting a credit card number over the Internet might lead to the following difficulties.First, there is the entire question of security. Credit card numbers may be viewed by unauthorized individuals because the Internet is an open system. In the real world, there are a number of means to minimize fraud. A customer using a credit card will usually opt to carry out transactions at trustworthy or familiar facilities, stores, and markets.Second, credit cards can be used only at authorized stores. Unauthorized small businesses or individuals generally cannot carry out transactions with credit cards. In other words, credit cards cannot be used for peer-to-peer payment. Cash encourages peer-to-peer payments.Third, credit card payments usually charge a small fee. Although this cost is low, it can be a significant cost when the payment itself is very small, such as less than 20 cents [4]. As a result, credit cards can not be used for micro-payments. Cash payments is used for even the smallest financial transactions.Finally, receipts from credit card payments leave residual records of expenditures. Those who issue credit cards know exactly what kinds of goods and services have been purchased, as well as where and when they were acquired. In other words, user's expenditures by credit card can be traced while cash payments are untraceable.Electronic payment systems, more or less, try to cope with the above issues [5]. According to the extent to which these systems cope with these problems, I classify digital cash programs into three categories.1. Credit Card Base Type
To minimize security risks and the loss of credit card numbers in transit, First Virtual Holding began a payment system in which users transmit passwords instead of credit card numbers when purchasing an item (See Figure 1-i) [6].
 | Customer sends his ID or encrypted creditcard number to the shop. Shop asks for payment to the Credit card company, which confirms customer by e-mail. After the confirmation, payment is done. Card number itself never goes through the Net.
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 | Person "A" isues his electronic check. He sends it to person "B" and informs the bank of his check. Person "B" asks for payment to the Bank. After the confirmation, the bank transfers money from person A's account to person B's.
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 | Person "A" asks the bank to issue digital cash. The bank issues digital cash and reduces his account by that amount. He sends it to person "B". Person "B" asks the bank for payment. After confirming that the digital cash is not double-spent, the bank increases person B's account by that amount. Note that the bank cannot know who sent that digital cash to person B. (Untraceability)
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Checks are closer transactionally to cash than to credit cards, because peer-to-peer transfers are possible. Micro-payments are possible as well though banks are reluctant to accept process micro-payments by checks thanks to the high operational cost of check clearance [7]. As a result, several proposals (CyberCash, NetCheck, and others) have emerged to invent checks on the Internet, which would be transferable between individuals [8]. As Figure 1-(ii) shows, a customer opens an account in a bank on the Internet, and issues an electronic check to pay a bill. The recipient of this digital check sends it to the Internet bank to confirm and cash it. Security is guaranteed by both encryption and the bank's confirmation process with the issuer of the check [9]. This system permits peer-to-peer payments and reduces fees to some extent. But transactions are still traceable since a bank can track the actual use of the electronic check.3. Cash Type
Cash transactions are untraceable and anonymous [10]. To achieve untraceability on the Internet, encryption has to be fully employed to prevent untraceable money from being easily copied and spent twice, a phenomenon known as double-spending. David Chaum as well Tatsuaki Okamoto and Kazuo Ohta have proposed untraceable electronic payment systems using advanced encryption technology [11].The mechanism in this system is similar to an electronic check, but it prevents banking institutions from linking purchasers to specific goods and services (see Figure 1-(iii)). How does this work? First, an Internet user opens an account with real money at an Internet-based bank. The customer asks the bank to issue a certain amount of digital cash for use on the Internet. The bank issues this digital cash using encryption and deducts the funds from the established account. An example of a bank that performs these sorts of transactions is Mark Twain Banks, operating since late in 1995 [12].This digital cash is a combination of two huge integers which have special mathematical relation. No other person or institution, but the bank, can imitate this relation. Any calculation that would attempt to duplicate this relation would take an almost infinite amount time in the absence of the bank's secret key.When an individual uses digital cash, this unique data that defines the actual electronic currency is given to the merchant. The merchant in turn sends this data to the bank to confirm it. If the bank confirms it, the bank credits the merchant's bank account by that amount, or alternatively issues the merchant a sum of digital cash in the same amount. Only the bank can confirm that this data - or, digital cash - is legitimate and actually issued by the bank. Only the bank can verify that this that this data has not been used elsewhere, or double-spent. The bank cannot know who used the digital cash, as long as customers of the bank do not use it twice.This payment system deserves the name of "cash on the Internet" because it is almost equal to a cash payment in terms of security, fee, peer-to-peer payment, and untraceability. I will now focus on this cash-type "digital cash."
With digital cash, financial transactions will become more efficient, which in turn will broaden new business opportunities. Problems? Certainly, taxing digital cash and the specter of money laundering are significant issues. Additionally, digital cash could introduce instabilities to exchange rates and upset the overall money supply. Let's first look at the primary benefit of digital cash.
Digital cash will make transactions more efficient in several ways. First, digital cash will make transactions less expensive because the cost of transferring digital cash via the Internet is cheaper than through the conventional banking system. To transfer money in the traditional way, conventional banks maintain many branches, clerks, automatic teller machines, and specific electronic transaction systems. Overhead costs for all of this bureaucracy is generated in part from fees for money transfers and credit card payments. Since digital cash uses the existing Internet network and the specific computers of its users, the cost of digital cash transfer is much lower, close to zero [13]. With the transaction completed within the Internet, the transfer fee and bank tips are zero, in case of the Mark Twain Banks [14]. This low cost for transactions enables micro-payments, like 10 cents or 50 cents, to be possible, which in turn may encourage a new distribution system and fee structure for music, video, and computer software. "Super distribution" is just one practical application [15]. This ability to finally handle micro-payments might also provide a solution for the payment of fees to authors and publishers for use of copyrighted materials in electronic form.Second, since the Internet recognizes no political borders, digital cash is also borderless. Thus, the cost of transfer within a state is almost equal to the cost of transfer across different states. The cost of international money transfers, now much higher than transfers within a given state, will be reduced dramatically. For example, now it may take more than a week to send a small amount of money to a foreign bank. But if a given foreign bank accepts digital cash, this delay is significantly reduced [16].Third, digital cash payments potentially can be used by anyone with access to the Internet and an Internet-based bank. While credit card payments are limited to authorized stores, digital cash makes person-to-person payments possible. Thus, even very small businesses and individuals can use digital cash for all sorts of transactions.The consequence of these effects is an enlargement of new business opportunities and an expansion of economic activities on the Internet. Even small businesses can trade with customers all over the world. Multinational small businesses will become a dynamic new force in local and regional economies [17]. For example, a high school student may use the Internet to sell his programs to a world-wide customer base, accepting digital cash as payments for his products. Not only will individuals and small companies benefit. Large firms will find digital cash efficient for international payments leading to less expensive and more sophisticated services for most customers.
1. Taxation and money laundering
Digital cash may cause some problems in part because it permits seamless transactions across national borders. Should sales taxes be imposed on Internet transactions? Suppose a Chinese software developer uses a server in the United States to sell his software, say to a customer in Japan. Which sales tax rate should be applied, and by whom? Which country should benefit from the tax? Conflicts over international taxation of digital commerce, which have appeared only occasionally so far, could intensify. This problem may need to be resolved by a whole new view on international taxation. Since digital cash is untraceable, not leaving well-defined records for a tax authority to follow, taxation will not be easy even if there are adjustments to tax regulations [18].The untraceability of digital cash may encourage criminal activities such as money laundering. Sending real money as digital cash means transport across national boundaries without any real evidence of transfer [19].As mentioned earlier, not all electronic money is untraceable. Traceable electronic payments will not cause taxation and other problems, thanks to residual transaction records [20]. If digital cash in its untraceable, real cash-like form spreads in cyberspace, taxation and illegal transfers of funds will become a serious issue [21].2. Macroeconomic effects
What are the possible effects of digital cash on large-scale, economic stability? Is digital cash a proxy for real currency or is it just privately-issued new currency?For the sake of this analysis, I will assume that digital cash is a proxy of currency in the real world. In other words, digital cash will be issued on the same terms as existing hard currency - digital cash of dollar, digital cash of yen - and can be exchanged to its hard currency equivalent at anytime.Some assume that since digital cash is issued by private firms, it is independent of government conditions [22]. If this assumption is correct, digital cash may have a kind of monetary freedom [23]. Nevertheless, it will be difficult for the public to trust a privately-issued currency, not controlled by the government in some fashion.The conditions that make government-issued money credible do not apply to privately-issued currency. Government-issued currency is the official currency of a given state, and is used, in spite of its value, by the citizens of a given state. Citizens can voice their views, in some cases, of economic policy and the value of government-issued currency during elections. Overall, within a nation, there is only one official currency, and there are no alternatives. These conditions do not hold true for privately-issued currency. If the value of a specific privately-issued currency begins to depreciate, those using this currency quickly dispose of it. This dumping may accelerate the depreciation of a given currency, and, in extreme cases, eventually lead to bankruptcy. This instability may discourage the use of privately-issued currency.If the value of digital cash is exactly equal to real currency, then digital cash is convertible to real currency at anytime [24]. For example, dollar-term digital cash would have the same unit as dollars and customers would be able to convert it to real cash. In other words, digital cash is not "new" currency in the sense that the dollar, mark, or yen are new [25]. Hence, we will assume that digital cash is cash backed (or created) by banks using real cash as a base, and that there is guaranteed convertibility to real cash. Even under these conservative assumptions, I envision several monetary problems.2a. Macroeconomic effects: exchange rates
Digital cash may potentially increase instabilities in exchange rates. Since digital cash is a proxy for real currency, there has to be an exchange rate applied to it. There must be a foreign exchange market in cyberspace (see Figure 2).
Digital cash may affect the money supply in the real world. Those using digital cash deposit real cash in a bank and request in exchange for this real money digital cash. If a bank issuing digital cash does not offer loans in the form of digital cash (a so-called 100% reserve system), the amount of digital cash will be fixed to the amount of the real cash on deposit. In this conservative case, no new money will be created.However, if the economy of the Internet expands, banks may chose to lend customers money in the form of digital cash. Banks will move to a virtual, fractional reserve system parallel to that found in the real world. New money will be created. In other words, the total amount of digital cash will exceed the amount of deposited real cash (see Figure 3).
This money creation could lead to the possibility of bankruptcy. But since there is no central bank in cyberspace, the bankruptcy of banks tend to cause chained-bankruptcy, that is, financial crisis. (Problem 4)
In turn, there will be a money multiplier of digital cash. "Money multiplier" in this case means the ratio of issued digital cash to deposited real cash, on reserve, in this cyber-economy. If the virtual economy develops like normal, real economies, this process can be expected to evolve over time.This development means that money in cyberspace fluctuates with virtual economic activity which in turn eventually has an impact on the real world's money supply. Suppose the virtual economy expands leading to a temporary shortage of digital cash. The demand for digital cash will mean the transfer of real cash to electronic banks. Cyberspace will absorb real cash and in turn shrink the money supply in the real world.This sort of interaction is not new. In the real world, economic expansion by one country will increase its interest rate, which will lead capital to flow in from other countries, contributing to a shortage of other money supplies elsewhere. But there are other complicating factors in cyberspace. First, since digital cash is a proxy of real cash, this interaction with money supplies will be more direct and rapid. In the real world, geography and fluctuating exchange rates dampen the speed and amount of capital flow. These barriers are minimal for digital cash. Therefore, the interaction between cyberspace and a given national economy may be more direct and rapid than that between two national economies. Second, since cyberspace is borderless with no central monetary authority, digital cash in the form of dollars can be issued by anywhere in the world. As the virtual system exists, it would be impossible for any one government authority to try to regulate the production of digital cash everywhere. These factors will make the monetary control for central banks potentially more difficult.2c. Macroeconomic effects: financial crisis
If banks begin to create new money in the form of digital cash, there will be an opportunity for bankruptcies, the chain effect of which may easily lead to a virtual financial crisis.A bank that issues digital cash within the limits of its real cash on deposit, and which does not lend, can respond to any and all demands of its customers for real cash. In this case, bankruptcy would be unlikely and the chain effect is limited. Nevertheless, the natural evolution of virtual finance will probably parallel the real world. Banks will loan digital cash beyond their deposits of real cash. This development may lead to bankruptcy of a given virtual bank, which in turn may cause other banks to default.In the real world, this risk is minimized by a safety net offered by central banks or institutions in the United States such as the Federal Deposit Insurance Corporation (FDIC). In cyberspace so far, there is no central banking authority that provides the equivalent of this safety net. For example, some forms of deposits in the Mark Twain Banks are not insured by the FDIC [28].It is possible that the default of one bank may lead to the defaults of other virtual banks. Customers may rush to their banks to demand a conversion of digital cash to real cash. If there are insufficient real funds on hand, there could be a financial crisis. In the absence of a virtual central bank, there is an increased risk for this sort of problem [29].The problems and benefits of digital cash will not occur unless the amount of digital cash in use is equivalent to a considerable percent of world GDP [30]. What is the critical characteristic of digital cash? If we can identify this characteristic, can we predict some consequences of the use of digital cash?3. Characteristics
What is the most important character of digital cash? One characteristic played an important role in all of the previously discussed cases: transnationality. Digital cash is not constrained by national borders. Those using digital cash can purchase services and goods from any site anywhere on the Internet. Banks issuing digital cash can do so relative to any stable, real currency.Transnationality makes international transactions more efficient. For example, in Japan, with traditional currencies the bank commission on an international money transfer is equivalent to about 20 or 30 dollars; for a domestic transfer, the fee is roughly 2 or 3 dollars. The cost reduction for international virtual transfers of funds should be quite dramatic. As discussed earlier, the problems for digital cash are also deeply rooted in this transnationality.To understand the importance of transnationality, let us assume that digital cash is completely domestic. That is, only a bank in a given state can issue digital cash in that state's currency. Only the citizens of that state can use this digital cash and only with merchants for products and services within the state. The benefit of digital cash will be reduced to the level of a new payment system equivalent to a new variety of credit or prepaid card. The prospect of multinational small businesses will be impossible. A potential worldwide customer base will evaporate.Regardless of these losses, the potential problems, caused by digital cash, will be far less serious. In this scenario, domestic taxes can be applied to electronic transactions. Money laundering may be possible, but it also will be more easily detected. With digital cash not traveling on the world's markets, there will be less incentive to participate in exchange rate speculation. Disturbance of the money supply will be minimized because a given central bank can control not only real cash but also digital cash by the conventional means. Both the benefits and problems of digital cash disappear if digital cash is completely domestic.Transnationality is a critically important characteristic of digital cash. If digital cash was affected by the borders of states, it would be considered just an efficient payment system like a credit card or an electronic transfer. There would be no significant economic implications. Credit cards and electronic transfers increase the efficiency of financial transactions, changing the velocity of money and raising the money multiplier [31]. But credit cards and electronic transfers have not caused significant problems that are possible with digital cash. Digital cash that respected the borders of states and followed the regulations of central banking authorities would pose few negative economic consequences [32].It's important to distinguish digital cash from so-called electronic money. Electronic money, as we know it today, is not transnational. A smart card system like Mondex is regarded by some as a form of digital cash [33]. But some smart card systems require specialized equipment, reducing their global reach [34].4. One Possible Scenario
Some of the consequences considered in this paper will only occur if digital cash is used extensively on the Internet. There are many who are anxious about the security issues surrounding digital cash [35]. If these concerns outweigh the benefits, digital cash will not spread. In addition, in the real world there are many regulations that protect the consumer and provide for financial stability. These laws could act as obstacles for the widespread use of digital cash [36]. In spite of these potential difficulties, I would like to consider at least one scenario, in which digital cash will become prevalent on the Internet.The widespread use of digital cash will turn cyberspace into a large-scale economy. The attendant benefits of digital cash, in this scenario, will be sufficiently plentiful to overcome security concerns. With an increased use of digital cash, what will happen? In this scenario, I will consider three stages of development.
4a. One Possible Scenario: Expansion StageDigital cash spreads on the Internet. Increased efficiency brings unprecedented benefits to both producers and consumers. Multinational small businesses gain momentum and new business organizations appear, the so-called virtual corporations. Consumers enjoy the ability to purchase goods and services anywhere in the world. Some banks, that decide adhere to traditional transaction systems, lose their competitive edge. The size of the cyberspace economy, measured by the total sales on the Internet or the GNP, grows at a more rapid pace than the economy of the real world.As long as the size of the cyberspace economy is smaller than the economy of the real world, effects on exchange rates and money supplies are limited. The main problems at this stage are over-taxation and criminal activities. These two areas demand an international accommodation of rules, such as an international standard taxation rule on Internet-based transactions and an international agreement on criminal investigations [37]. The process of making these new rules may lead to harsh negotiations between different states. The new rules may be a patchwork of regulations that may not change the fundamental characteristics of digital cash [38]. It is possible that in spite of these regulations, the use of digital cash will expand.4b. One Possible Scenario: Confusion Stage
The expansion of digital cash will eventually enlarge the cyberspace economy so that it will have a significant impact on the real international economy. For example, suppose the amount of transactions in cyberspace are 5% of the total of all international transactions. There is the possibility then of effects on the exchange rate and money supply. There will be resistance to any sort of control or reform of digital economic activity. This resistance may indeed confuse the general public, politicians, and bureaucrats. It may require the shock of a financial crisis to bring some order to virtual transactions.4c. One Possible Scenario: Organizing Stage
If a financial crisis actually occurs, what kind of reform might be possible? There are two possibilities: territorial segmentation of cyberspace by national states or alternatively, the establishment of a monetary authority in cyberspace. In the first case, every bank on the Internet would fall under the jurisdiction of some nation and be controlled by the central bank of that specific state. The central bank, in turn, would be responsible for the control and circulation of digital cash. For example, regulations would be introduced to prohibit digital banks from "printing" digital cash in foreign currencies just to stabilize exchange rates [39]. With these sorts of controls, digital cash will lose its transnationality. This sort of reform would represent a colonization of cyberspace by nation states.The division of cyberspace into national states obviously would not be a satisfactory solution for most netizens [40]. Another possibility would be to establish a monetary authority in cyberspace just like a central bank in the real world. The organization of this monetary authority may represent a union of the banks on the Internet, a committee of technical experts and bankers, or a group of netizens elected on a routine basis in cyberspace. However it may be founded and organized, this authority would be responsible for the financial stability of digital economics and ensure its proper links to reality. All banks issuing digital cash would have to accept the authority of this international, digital monetary bureaucracy.However, if digital cash remains a proxy of real cash, this monetary authority will not be able to perform its role well in the absence of a right to issue real cash. In the real world, a monetary authority can issue real cash to any extent as a last resort of credit. If digital cash remains a proxy of real cash, this newly created virtual authority would not be a last resort of stability in the face of a potential crisis.Suppose this authority could create a completely new, digital currency that we will call e$. e$ would be a new currency similar to the dollar or yen but only the virtual monetary authority could issue e$-term digital cash. Other banks on the Internet would use this cash as a base money. As a consequence, cyberspace would obtain sovereignty and monetary independence [41].An independent agency governing virtual financial transactions is not a completely remote possibility. There are a number of suggestions that encourage the independence of cyberspace relative to reality. This independence will foster the growth of different kinds of organizations to exert some control over Internet-based activities [42]. The absence of these sort of bureaucracies and authorities may mean that the history of digital cash is really a description of one of the many battles between cyberspace and nation states.
Digital cash will provide benefits and problems in the near future. It is the very transnational character of digital cash that will open new business opportunities around the world but also bring vexing problems for governments. The solutions to these problems may very well lead to a more controlled cyberspace with parallel structures and regulations governing the use of funds. Alternatively, the economy of the Internet may be regulated by those who best know cyberspace, the netizens, technicians, and agents of this borderless place, in the form of new and responsive digital bureaucracy. The economic consequences of the large-scale use of digital cash clearly indicate that some form of control will occur. Only time will tell if the history of virtual commerce will be peaceful, successful, and tightly coupled with current operational features of the international financial community
XXX . V0000 ELECTRONIC CASH AND MONETARY
New payments technologies are heralding what appears to the greatest union of the disciplines of science and money since Sir Isaac Newton, Master of the Mint, unwittingly put Great Britain on the gold standard, back in 1720.
Web sites about digital cash and other electronic payment systems have been proliferating wildly. Moreover, every major newspaper, business magazine, and evening television news broadcast seems to have featured at least one story about "electronic money" or "digital cash." There are now about at least four paperback books on electronic cash, each of similar thickness, appearance, and price, for sale in North American bookstores. No doubt there are more such books on the way. To top it all off, Nicholas Negroponte has called 1996 "the year of electronic money." Professor Negroponte and other analysts talk about a revolution transferring power from governments and central banks to investors, consumers, and entrepreneurs.
Not, perhaps, for everyone. Take, for example, the country where Professor Negroponte made his declaration - France. The French experience with electronic commerce via smart cards and minitels dates to the 1980s - ancient history to most Internet users. Moreover, Japan and much of Western Europe have long used prepaid telephone cards.
In contrast, it is only now that smart cards and other implements of electronic commerce being developed for the "Anglo-Saxon" economies [1]. Aside from Danmont of Denmark and Avant of Finland, developments in electronic commerce in the non-English-speaking world have not been well reported in the English-speaking press. At the end of this article, I have listed a couple of Internet sites that shed more light on these activities.And what of this new revolution taking power from the hands of politicians, civil servants, and central bankers, and placing it in the hands of theaverage citizen? There are actually two electronic money revolutions underway - an electronic money revolution and an electronic cash revolution. Let me define the terms: - "Electronic cash" is the digital replacement for banknotes and coins, in other words, electronic money for small transactions. - "Electronic money" includes electronic cash, as well as the immense torrents of digital funds that zip through international and national payments networks [2], The electronic cash revolution is bringing electronic money to the ordinary consumer and merchant. For the "Anglo-Saxon" economies, this revolution is only just beginning. It is the electronic money revolution that has shifted so much economic power from the State to financial markets. This revolution arrived some years ago. It has already shaken the landscape, as the European Exchange-Rate Mechanism crises of 1992 and 1993 attest. Worldwide liberalization of government controls on capital outflows - combined with new telecommunications and computing technologies - have enabled huge electronic "hot money" flows to flash around the globe in search of the highest returns. Nowadays private-sector financial capital greatly outweighs central bank foreign-exchange reserves and international trade-related flows, although until a few years ago this was not the case.
Electronic money is neither new nor all that exotic. According to a U. S. Treasury official [3], Western Union made the first electronic funds transfer (EFT) in 1860, the year that Lincoln was first elected President of the United States. This EFT was made by telegraph, and was an analogue rather than digital payment, but it was an electronic payment nonetheless [4]. Moreover, the technology to support this type of EFT dates back to May 1844, when Samuel F. B. Morse first demonstrated the telegraph. Indeed, Fedwire started as a Federal Reserve telegraph system as long ago as 1918. And SWIFT and CHIPS date to the early 1970s.
Electronic money is an old concept; moreover, most money is already electronic. In the U.S. and other economies, banknotes and coins compose only a small percentage of what we conventionally define as "the money stock." Only the narrowest monetary aggregate, M0 - used by few except the British - is composed chiefly of metallic and paper currency [5]. The narrowest monetary aggregate into which most conceptions of electronic cash would fall, M1, is composed of currency, traveler's checks, demand deposits, and other checkable deposits. In countries that make heavy use of checks, like the United States, banknotes and coins comprise only a minor share of M1. The broader the monetary aggregate, the smaller the share of banknotes and coins.
Although the electronic money revolution has made an enormous economic impact, it is the electronic cash revolution that has captured the imagination, stimulating new interest in the nature of money. The first central banks to seriously study electronic cash have been smaller West European institutions, such as the Nederlandsche Bank and the Bank of Finland. The Dutch central bank's attention to electronic cash is largely due to the location of DigiCash and similar ventures and research centers in the Netherlands. In an interesting instance of socialism or state entrepreneurship (take your pick), the Bank of Finland actually has a corporate subsidiary, Avant Finland Ltd., developing that country's Avant cash-card system. In contrast to the cybersavvy smaller West European central banks, the more powerful central banks, such as the Federal Reserve and the Bundesbank, have gotten a relatively late start studying the new technologies. For some time, the Bundesbank's reactions to electronic cash fell somewhere between suspicion and disdain. But this past November, it was Bundesbank President Tietmeyer who convened the Group of Ten central banks to study this issue [6]; the G-10 report should be available in a few months. Top-level American central bankers have likewise studied the issue only recently. A couple of years ago, when asked about digital cash, then-Federal Reserve Vice Chairman Alan S. Blinder replied "Digital what?", adding a few moments later, "It's literally at the thinking stage [7]." In the United States, the Domestic and International Monetary Policy Subcommittee of the House of Representatives Banking Committee has been holding occasional hearings on "The Future of Money." http://www.house.gov/castle/banking/money.htm These hearings feature electronic entrepreneurs, bank executives; university professors; managers of urban mass-transit authorities using "closed" stored value systems; Federal law-enforcement officials, the U.S. Treasury executives, and a Vice Chairman of the Federal Reserve Board. Aside from the Director of the Mint, who would welcome the opportunity to issue commemorative cash cards, the U.S. Government has adopted a wait-and-see attitude toward electronic cash. This results from a reluctance to inhibit private-sector development of new payment techniques and technologies.
The leading common technical standard for cash cards, EMV, was developed by the private sector, specifically Europay, MasterCard International, and Visa International. The private sector is also developing security standards on its own, even challenging hackers to break their codes for a reward. Had the U.S. Government wanted to dictate standards, it would have been in a good position. The U.S. Department of Agriculture is exploring the digitization of "Food Stamp" coupon for indigent American families. The Department of Defense's worldwide network of base facilities, including commissaries and PX's, also could have given the U.S. Government substantial influence over standards. In recent years, the Working Group on Payment Systems of the European Union has presented studies on new payments technologies to the Council of the European Monetary Institute (EMI) http://www.kub.nl:2080/library/instructie/eue/24monet.htm, the embryonic European Central Bank. In its May 1994 study on prepaid cards, the Working Group on Payment Systems called for limiting the issue of electronic cash to "credit institutions," in other words, banks. This approach would seem instinctive to any central banker, because banks are already subject to supervision. However, because of the ease with which nonbanks can now issue money, Dutch central bankers now believe that all issuers of electronic cash should be regulated, bank and nonbank alike.When is an Institution a Bank? When is a Prepaid Card Balance E-Cash? In early April 1996, the Board of Governors of the Federal Reserve System issued its proposed modernization of Regulation E, the main regulation governing electronic financial transactions in the United States. The new "Reg E" would waive paper receipts for small transactions, and for the first time establishes rules for stored value cards. There have also been several bills introduced into Congress that substantially rewrite the Electronic Funds Transfer Act, the legislation that governs "Reg E." Minneapolis attorney Chris Sand berg discusses the legal issues affecting digital cash in InfoNation magazine. http://www.info-nation.com/cashlaw.html Even aside from the inevitable modernization of the laws and regulations governing "e-cash, [8]" long-established notion are being turned on their head. For example, what is a bank? Is it any institution that lends money? That accepts deposits? That lends money and accepts deposits simultaneously? The commonly accepted definition of bank is fast becoming outmoded. Many have observed that it would not take much for Microsoft or AT&T and other large software and telecommunications firms to expand into the banking business.What is electronic cash? When does the balance on a multipurpose card become electronic cash? When does stored value qualify for deposit insurance? When must stored value card issuers maintain reserve requirements? These questions raise issues that transcend the academic. What is and what is not electronic cash - or any other form of money - is not a simple yes-or-no question, but rather a matter of degree. Money is usually a liability of its issuer, effectively an interest-free loan to the issuer from its holder. Nonetheless, precisely because money is a matter of degree, the definition of money is rather ambiguous. Let us assume that all the photocopiers in a university library require the use of a university-issued prepaid card. We would consider this card arrangement a "closed system." What if vending machines at the university library are retrofitted to accept our photocopier card? Our closed system has gotten a tad more open. Now assume that all the vending machines and photocopiers throughout the campus accept the library photocopier card. What to obtain a copy of your transcript? What if the university registrar, and every university department and instrumentality on campus accepts photocopier cards? Now, what if the five colleges and universities in the metropolitan area accept each other's photocopier cards? What if, soon thereafter, off-campus laundromats, restaurants, and newsstands at each of these institutions accepts photocopier cards? Is the balance on the photocopier card cash? Well, the single-purpose card has unquestionably become a multipurpose card, a relatively open closed system. But it is not cash yet, because it is not universally accepted. Now assume that all the photocopiers and vending machines and off-campus businesses suddenly accept VisaCash, MasterCard Cash, and Mondex cards. These would be open systems, presuming that every local establishment has the equipment to process electronic-cash transactions. The cash cards, if issued by a bank, would be protected by deposit insurance. Moreover, it is likely that the Federal Reserve would require some sort of reserves to back the electronic cash. Would banks be required to issue electronic cash with the same reserves as those required for savings and checking accounts? Today, for most banks, the reserve ratio is a mere three percent. In other words, for every dollar of electronic cash created by a bank, there need be only three cents in bank reserves. Today, under current U.S. law, a nonbank institution is free to issue multipurpose cards without any reserve requirement. However, these nonbank cash cards are not be protected by Federal deposit insurance. Hence, Dutch central bankers recognize that all electronic cash issuers, bank and nonbank alike, must be monitored by the monetary and banking authorities. But the existence of multipurpose cards make the issue quite difficult to sort out. When hotels and gasoline stations accept frequent-flier miles, those miles become a quasi-currency. Several weeks ago, a U.S. Government prosecutor asked a Federal court to confiscate the frequent-flier miles of a captured marijuana smuggler. His home, financial savings, and other property had already been seized by Federal authorities. The smuggler had accumulated enough mileage to qualify for three round-trip visits from the United States to the Bahamas.
In Western Europe, new developments in monetary technology share the headlines with attempts to establish Economic and Monetary Union (EMU). EMU now seems an uncertain proposition. Among the signatories to the Maastricht Treaty, only Luxembourg now meets the convergence criteria for Economic and Monetary Union (EMU). The political momentum for a single European currency so visible immediately after the signing of the Maastricht Treaty has dissipated. Although Tim Jones, CEO of Mondex says that his Mondex card would be an ideal vehicle to test electronic Euros, others believe that electronic cash, far from aiding the Euro, could deliver its coup de grace.
Giles Keating, chief international economist at CS First Boston in London, believes that electronic money might derail Economic and Monetary Union (EMU) in Europe. In a guest column in the November 2, 1995 Financial Times, Keating reminds readers that many of the electronic cash technologies accommodate several currencies simultaneously on a home computer or a cash card. Moreover, the new technologies dramatically reduce foreign-exchange transactions costs. A resident of a country with a chronically weak currency could easily shift his savings into stronger ones. Indeed, there could easily be a massive flight of electronic financial assets from weak currencies to stronger ones, effectively driving the weaker, less significant currency out of existence - a sort of Gresham's law in reverse. Ultimately, those European governments with terminally weak currencies would be able to compel the use of their currencies for "legal tender transactions" only, such as income taxes and driver's license fees. If the electronic cash became widespread, then for every dollar of banknotes or coins replaced by private-sector electronic cash, the Federal Reserve System, through its open-market operations trading desk in New York, would be obliged to sell one dollar of U.S. Government securities. Moreover, the Federal Reserve, and ultimately the U.S. Treasury, would lose the interest income that it would have earned otherwise [9]. Note that the electronic cash would not be a private currency. Instead, to be accepted by the U.S. banking clearing and settlements system, it would have to be denominated in the official U.S. unit of account, the dollar. The widespread adoption of electronic cash would deprive Federal authorities of a substantial amount of "seignorage," the margin between the face value of currency issued, and the costs of issuing that currency. In 1994, the Federal Reserve turned about $20 billion in seignorage over to the Treasury.
In his essay "Digital Cash and Monetary Freedom," Jon W. Matonis, an executive with the digital certificate developer VeriSign, Inc., points out that the new technology offers the possibility of privately-issued currencies. Matonis takes his inspiration from the late Professor Friedrich von Hayek, whose essay "The Denationalisation of Money" includes the following quotation: Money does not have to be created legal tender by government: like law, language and morals it can emerge spontaneously. Such private money has often been preferred to government money, but government has usually soon suppressed it. This is a theme that can be traced as far back as the 1851 writings of Herbert Spencer, the father of "social Darwinism" and a strong opponent of government intervention in the economy. Matonis is quite correct that the new technology makes easier the use of multiple private currencies. There is no reason why Intuit, Meca or Microsoft cannot develop an intelligent agent to optimize the value of the digital currencies stored in one's hard-disk drive or PC card. Such an agent would resemble a foreign-exchange or corporate treasury trading desk. Moreover, any Internauts are quite enthusiastic about the idea of "currency competition." But why would anyone want to hold a private currency when there are so many strong national currencies about? This is not merely a matter of "free banking," but of the introduction of who new units of account. Despite advanced technology, dealing with multiple currencies seems unnecessarily confusing. The whole idea of private currencies seems preposterous. Yet Friedrich von Hayek was no crank, nor are his followers. In many respects von Hayek was ahead of his time. At a time when the economic establishment - including Republican and Conservative leaders - accepted the Phillips curve analysis that a little inflation was a small price to pay for more employment, it was von Hayek who condemned inflation because it distorts prices, which serve as essential information signals in a market economy. Why use Microsoft dollars or Virgin Atlantic sterling when there already is the Deutsche mark? If you reply that the D-mark may not be around too much longer, then why not use the Swiss franc, the New Zealand dollar, or the Japanese yen? I do not know whether Microsoft will be around in a century to redeem Bill dollars, but I am relatively certain - the USSR, Yugoslavia and Czechoslovakia notwithstanding - that the United States will be around. Why should a private-sector currency be any more stable than a national one? This seems more an article of theology than of economic logic. Assume that, for the past century, we all had lived in a world of private currencies. What if, one day while cleaning out the attic, you suddenly happened upon Grandpa's stash of Eastern Airlines dollars? Fond memories of Eddie Rickenbacker and Frank Borman may remain, but Eastern Airlines doesn't. Gramps' Eastern dollars would be good for wallpaper and birdcages, but not much more. There is no statute prohibiting any U.S. citizen from issuing his own currency. According to Sir Samuel Brittan of the Financial Times, this is also more or less the case in the United Kingdom. If, as Professor von Hayek alleged, privately-issued money can arise as spontaneously as law, language and morals, why is it not here? In his essay on private currencies, Hayek blamed capital controls for the failure of private currencies to develop. Yet capital controls are largely gone, and there are still no private currencies. There are two answers. First, there really is no demand for any private-sector form of money other than brand-name traveler's checks and your own demand-deposit and money-market-fund checks.
This past autumn, National Westminster Bank PLC encountered a problem with its credit-card authorization network. NatWest blamed the equipment's supplier, British Telecommunications PLC. BT blamed NatWest for overburdening the computer system. NatWest and BT are also collaborators on Mondex. Suppose that Mondex' security were breached, and NatWest and BT engaged in another round of fingerpointing? At the end of the day, money is about confidence. Public recriminations can easily be as devastating to confidence in an e-cash product as an actual breach of security. The development of contingency plans and crisis-management skills do not receive much public attention. Perhaps, to some extent, effective contingency planning requires some discretion. Nonetheless, this seems an issue that merits attention from central banks and other banking authorities.
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