The Circularity Trap: A Two-Sector Simple Model of Growth, Labor Reallocation and Industrial Stagnation in Developing Economies

This paper introduces a dual-sector growth model to investigate the “circularity trap,” a phenomenon where increasing the Circular Material Use Rate (CMUR) leads to a decline in total value added per worker in developing economies. While circular economy policies are designed to promote sustainability, we demonstrate that in small open economies with a significant productivity gap between a high-tech manufacturing sector and a predominantly low-tech, labor-intensive recycling sector—a common feature in many low-income contexts—aggressive circularity targets can trigger a form of “Environmental Dutch Disease.” Using a Cobb–Douglas framework, we model the reallocation of labor driven by the processing of imported waste. We show that as the CMUR ( ϕ ) increases, labor is drawn away from manufacturing—a sector characterized by technological learning-by-doing—into the recycling sector, which lacks similar growth externalities. Our results indicate that the circularity trap occurs when the marginal gains from waste processing are outweighed by the structural loss of industrial capacity and the slowing of total factor productivity (TFP) growth. The paper concludes that for low-income nations, circularity policies must be coupled with internal technological innovation to avoid long-term economic stagnation and de-industrialization.