01 - 02 Mixed Signals : Market Incentives , Recycling and the Price Spike of 1995

Environmental economics assumes that reliance on price signals, adjusted for externalities, normally leads to efficient solutions to environmental problems. We explore a limiting case, when market volatility created “mixed signals”: waste paper and other recycled materials were briefly worth an immense amount in 1994-95, then plummeted back to traditional low levels in 1996. These rapid reversals resulted in substantial economic and political costs. A review of academic and business literature suggests six possible explanations for abrupt price spikes. An econometric analysis of the prices of wood pulp and waste paper shows that factors that explained price changes in 1983-93 contribute very little to understanding the subsequent price spike. From the econometric analysis and from other sources, we conclude that speculation, rather than “rational” economic factors, must have played a major role in the price spike. If speculatively driven price spikes can disrupt an environmentally important industry such as recycling, then the surprising implication for public policy is that measures to control or stabilize prices, far from interfering with the market, may actually help to make it more efficient. 1 Thanks to Sumreen Mirza for skillful assistance in data analysis. Helpful comments on an earlier draft were provided by Maarten DeKadt, Laurie Johnson, Thomas Kinnaman, Paul Ligon, Chaz Miller, Dick Parrott, and Irene Peters. G-DAE Working Paper No. 01-02: “Mixed Signals”