A triple helix of market failures: Financing the 3Rs of the circular economy in European SMEs

Abstract

The Circular Economy (CE) shows hope to tackle our unprecedented climate catastrophe. However, there are market failures of double externality related to such environmental innovations (EI). CE market is evolving and has a unique financial circular risk attached to its business model that challenges standard financing instruments. The double externality market failures and the circular risk are termed as three (environmental-knowledge-financial) reinforcing market failures – a triple helix of market failures. The environmental externality, knowledge spillovers, and financial risk, all make a strong case for private and public sector contributions. Financing of CE is crucial, especially, in the case of European SMEs due to their traditional barrier to accessing finance including private costs, industry standards, lack of human and technological capital, limited information, and low market demand. In this paper, working with EU-wide SMEs data we investigate the impact of different sources of finance on a core reduce-reuse-recycle (3R) strategy of CE. The paper contributes to the literature by providing an empirical analysis of the different forms of finances including new instruments i.e., crowdfunding and capital market funding. In addition, the research contributes by assuming and encouraging discussion on embedded socio-institutional differences among countries. The study groups European countries into leaders, performers, and catchers, using the EI index that proxy measures underlying regional heterogeneity – EI frontiers – to support CE-related activities. The Probit estimates support this heterogeneity amongst the EU countries in utilizing financial instruments and assess the impact of a cohesive financing policy in terms of adopting 3Rs in SMEs. Under a cohesive policy, the adoption level is estimated at 61% for leaders, 65% for performers, and 49% for catchers. The results also show self-financing to be the most effective method of internal financing, which implies that the problem of double externality does not discourage internal financing. Moreover, alternative financing is the most effective method of external financing, which shows that the financial sector is offering innovative solutions to the circular risk of CE. The results of this study are relevant for a smart, sustainable, and inclusive global transitional CE policy.