The famous Milton Friedman pencil case concerning the circular economy and integrated reporting is the topic of this post.

Milton Friedman’s “pencil case” can be found in his book Free to Choose. A shorter but sufficiently explanatory version is available in this YouTube video. What can be understood even by laymen is that no such person, no such intelligence, no such power could understand and organize all the steps in the production of even a simple pencil. Cooperation of thousands of producers from all over the world, steel miners, loggers, graphite and brass producers, ink producers, truck drivers, and shopkeepers (to name a few), who don’t know each other and who may even hate each other for various reasons, unintentionally work together so that I can end up buying a pencil for a few cents.

Endless circularity of the economy

In making such a purchase, I am paying for a tiny fraction of an effort by thousands of workers along the pencil line, none of whom I have the slightest idea who they are, where they are, or what they care about. At the moment of purchase, I am in an indirect relationship with all of them. I influence their lives, and they influence mine. We are all in a well-connected circle. This circle is well connected, even though there is no outside force, no outside central office, no central planning authority that would or even could draw the lines of such a circle.

Indeed, the circle does not end with me. I could draw a picture with such a pencil that would make someone happy. I could use such a pencil to draw a car’s license plate that was involved in an accident. And I could, sooner or later, dispose of it as waste that produces some heat for the local district heating plant, which supplies its customers with hot water, allowing the worker to feel clean while he assembles pencils in the local workshop.

All of the above activities, and umpteen others not mentioned but equally important to the life of a single pencil, occur as a result of thousands of individuals seeking personal marginal utility and personal advantage. No central authority calculates the steps, the relationships between them, or the values of individual transactions. The Amazonian lumberjack cares about his wages; the Amazonian lumber mill owner cares about the margin he can make by selling lumber, but neither of them knows anything about the happiness triggered by my drawing of a pencil they unintentionally helped produce. All they know is the prices they can get, and all I know is the price I have to pay to get a pencil. The pencil is an emergent property of an immensely complex circle of activities that could not, in principle, be managed by any central authority.

Economy ruined by the central authority

This is why the European Union’s current centrally planned circular economy program is not only pointless but also counterproductive. A circular economy happens exactly because no central authority interferes. When a central authority intervenes, as in Soviet Russia or any similar regime (as is currently the case in the EU), not only does the circular economy collapse, but so does the economy as such. The economy exists only as a circular economy.

While it is clear that circularity cannot be centrally planned and that it is based on individual/personal decisions guided by information provided by prices, this does not mean that the individuals involved in this circularity live only in one dimension, a pencil/price dimension. Humans are neither homo-pencilus nor homo-economicus. When we use the pencil, we disseminate information directly related to the pencil price and a vast array of related information (all of which has some value to specific markets or audiences). We show our pride, which allows us to make friends who might help us sell our services. We demonstrate our precision with a sharp pencil, which helps our boss trust us more. There are many products/effects of such a pen for our personal economy. We could report such effects (by no means all positive) in an integrated report.

Producers do even if they do not know

Just as individuals are not narrow single-use beings (greed), though we all seek to buy the cheapest goods and get the highest price when selling our skills, so too does the pencil maker operate in an enormously complex input-output framework, and not just as a buyer of wood and seller of compound pencils.

The pencil maker cares not only about the flow of natural capital inputs and outputs but also about the flows and outcomes of social, human, intellectual, manufactured, and financial capital. The pencil manufacturer might deposit large sums of financial capital with a local bank so that a local start-up can launch a new product. He might lay off a few workers who become criminals, increasing the social cost to the pencil producer. He might find the cost of wood for pencils too high and develop cheaper substitutes from recycled plastic waste. He is responsible for deciding on all the capitals he oversees and the effects they produce.

Produce and talk, or shut up!

No other entity, be it the municipality, the environmental agency, the European Union, or the United Nations, can or should decide in his place. But at the same time, understanding the value of the information he provides, he reports. He does not report to any government agency but to meet the needs expressed in his business’s value chains. In totalitarian economies, dictators are essential elements of their value chains, so they report primarily to them rather than customers. For the same reason, he reports primarily to various national and supranational agencies in the EU and the US. But that’s already another story for another post.

I want to point out that the leading players in the economy, the companies, are required to report only. Only those who are agents of production should report since they are part of the circular economy. If they do not understand the overall complexity, they at least participate in it. Institutions that observe this circular economy from the outside, such as governments, government agencies, various NGOs, and the like, who can neither participate productively in the economy (they only collect taxes) nor understand the circular economy (since no one can), should remain silent on both the circular economy and integrated reporting.