The International Debate and Economic Consequences of Eco-Labeling

In this paper we analyze the effectiveness of eco-labels in reducing the supply of eco-unfriendly products. We focus on the situation where a labeled product is viewed by consumers as a private good and develop a theoretical model to pin down the interaction between consumers' willingness to pay a higher price for a labeled product and producers' incentive to produce them. Based on the model results, we conclude that labeling is an effective device in solving the problem of asymmetric information on the part of consumers and does provide a market-based solution to the problem of eco-unfriendly methods of production. In particular, we focus on the incentive problems that producers face in the event of imperfect and costly monitoring of labels and conclude that (i) absent increased enforcement, there is a tendency for eco-labeling schemes to increase the number of products with false labels; (ii) there is a Kuznet's U-curve relationship between the supply of eco-friendly products and national income in the sense that it pays domestic governments to increase monitoring intensity of labeled products only after income crosses a threshold level and (iii) technology transfer from the developed to the developing countries that enhances the cost effectiveness of eco-friendly producers reduces the incentive for producers to use false labels. There is, however, the danger that labeling programs, especially the ones including production and process standards, will be misused as non-tariff trade barriers towards exports from developing countries. In order to avoid this, governments have to ensure active participation in the development of internationally accepted standards. Furthermore, there must be increased transparency on the existence of eco-labeling programs.