On the Economics of Eco-Labeling

University Of Wyoming, Laramie WY

Investigators

Abstract

While there is evidence that consumers would be willing to pay a premium for items produced using "environmentally friendly" techniques, they are often unable to express these tastes because an asymmetric information problem. Consumers cannot typically tell the type of production process the firm has used, so they can't determine when it is environmentally friendly. Since the environmentally friendly technique is generally more costly, firms would be disinclined to choose such a technique, with larger pollution flows resulting. In response to this problem of asymmetric information, eco-labeling programs have emerged in a wide range of countries over the last decade or so. The research in this project models eco-labeling as an imperfect and costly test of product quality, where quality is interpreted as "environmental friendliness." The study determines the set of possible equilibria, the welfare implications of the introduction of an eco-labeling option, and the potential for eco-labeling to provide a regulatory alternative to more traditional methods. This project has important implications for public policy towards environmental regulation. When firms are privately informed about production and abatement costs, as in the context of this project, environmental regulation is notoriously difficult. Whether society opts for a traditional regulatory approach, using pollution taxes or abatement standards, or a market-based approach, for example using tradable permits, there will be costs to society associated with the informational advantage that firms have over regulatory agencies. Appealing to outside interests, as with eco-labeling, can allow environmental regulators to overcome their informational disadvantage at relatively low cost. On the other hand, the certification process is costly to firms, costs that must ultimately be paid by consumers. This project outlines conditions under which eco-labeling is preferable to a more traditional regulatory approach.