Testing for market efficiency

Testing directly for the "efficiency" of markets is exceedingly difficult. In effect, the researcher must compare actual price levels (or trade volumes) with those that would exist in a counterfactual "ideal" market. In principle this requires data on all the likely determinants of supply and demand for the commodity in question. In the area of recycling this is not possible. Moreover, in some cases the market itself may not exist as a consequence of failures (i.e. transaction costs are such as to remove all potential gains from trade), further complicating the analysis.

However, to cast some light on this question, efforts were undertaken to examine the determinants of recycling rates in OECD countries. This uses data submitted annually by OECD member country governments to the OECD Environment Directorate as part of its work programme on environmental information and outlooks. The data covers 20 OECD countries, over the period 1985-2000, and includes information on glass and paper recycling. As a first step, a reduced form model of glass recycling rates in OECD countries was estimated in order to see if some important determinants had the expected effects. It was found that glass recycling rates are affected in the expected manner by variables such as GDP per capita, labour costs, degree of urbanisation, population density and policy shocks (see Annex 2 for details).

In a more informal manner, in Chapter 4, van Beukering compares the ranking of different forms of recovery of used tyres (incineration, retreading, reuse, etc.) in a number of European countries against their ranking in terms of financial viability, and finds that the two quite likely diverge. However, he argues that this is likely to be largely explained by the different nature of policy interventions in the different countries rather than inefficiencies within the markets themselves.

In the absence of the possibility of comparing existing market performance with some counterfactual "ideal", more rudimentary measures are required. Price volatility can be considered an indicator of market inefficiency. Indeed, it is widely argued that price volatility in secondary material markets is very high. (See, for example, Kinnaman and Fullerton, 1999; Ackerman and Gallagher, 2001; SRMG, 2000; CIWMB, 1996; Porter, 2002; Blomberg and Hellmer, 2000; and Ecotec, 2000.) However, price volatility in and of itself is not a reflection of inefficiency in the market: efficient markets can have very volatile prices (i.e. for seasonal products which are perishable); and, inefficient markets can have very stable prices (i.e. a monopolist market which is not subject to demand shocks).

It can also arise from the structural characteristics of the sector, such as the widespread observation that both supply and demand are inelastic for many secondary material markets, including glass, paper, aluminium, plastics, and lead. (See Kinnaman and Fullerton, 1997; Palmer et al. 1996; Kinkley and Lahiri, 1984; Sigman, 1995; Blomberg and Hellmer, 2000; Edgrenc and Moreland, 1989; and Bingham et al,. 1983.) Supply inelasticity appears to be a particular problem due to capital-specificity. On the demand side, the use of the secondary market as a "residual" can lead to significant shocks. Under such conditions, prices are likely to fluctuate wildly.

However, in many cases price volatility can arise from some of the market imperfections discussed above (i.e. transaction costs leading to thin markets and variability in quality). As such, price volatility can be (but need not be) a reflection of market imperfections. This is significant since price volatility can have adverse implications for the long-term development of recycling markets, by introducing and reflecting uncertainty in the market. For instance, Wilson (2002) believes this to have been the case for the plastic bottle recycling sector.

In the longer term, such uncertainty can discourage investments with long planning horizons, even if the average rate of return is comparable to other investments. If investments are irreversible but flexible in terms of timing, recent work indicates that a more cautious approach to investment is optimal if there is input or product price uncertainty (see Pindyck and Dixit 1994). In such cases, firms will be reluctant to invest in material recovery.

In fact, a number of economists have seen such price uncertainty in the market for secondary materials as an important "brake" on investment. (See Kinnaman and Fullerton, 1999 and Blomberg and Helmer, 2000 for discussions.) It is, therefore, important to determine whether secondary material prices are actually particularly volatile. Table 1.6 compares the standard deviations of monthly price changes for different pairs of "substitute" primary and secondary materials, using American data from the Bureau of Labour Statistics. In most, but not all cases, prices for the secondary material are more variable than prices for primary materials. The exceptions are reclaimed rubber relative to synthetic and (particular) natural rubber, and zinc scrap relative to lead and zinc ore.20

Is there anything that public authorities can do to address price volatility? Some governments have introduced "price-smoothing" policies, as in California (i.e. CIWMB), but these are likely to be little more successful than they have for other commodities. Moreover, it is clear that some policies have actually exacerbated volatility - i.e. the "glut" of supply of recyclables in the mid-1990s due to collection programmes. As such, perhaps there is little that can be done directly in this area - not least since price volatility may reflect a well-functioning market.

Table 1.6. Standard deviations of monthly price changes for selected primary and secondary materials

Textiles

Processed yarns and threads

0.36

Textile waste

2.08

Rubber

Natural rubber

6.25

Synthetic rubber

1.66

Reclaimed rubber

1.40

Zinc

Lead and zinc ore

4.59

Zinc scrap

4.50

Aluminium

Aluminium ingot

3.68

Aluminium scrap

6.29

Copper

Copper ore

1.64

Copper scrap

5.57

Iron

Iron ore

1.64

Iron scrap

5.73

Paper

Pulpwood

1.80

Paper-making woodpulp

3.98

Wastepaper

9.24

20. In some cases where substitution can occur at different points in the production chain more than one

"primary" material has been selected. Figures illustrating monthly price changes are presented in Annex 3.

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