Harmonizing welfare and externalities: unraveling the product versus process standards puzzle in regulatory policy

There are two types of regulatory standards depending on the externalities they are designed to address. One is product standards targeting negative consumption externalities; the other is process standards addressing negative production externalities. Notably, the institutional arrangements for the two types of standards can be different in practice. For instance, the World Trade Organization applies national treatment (NT) to product standards, but its case law favors mutual recognition (MR) for process standards. This paper evaluates the welfare implications of this well-known product/process distinction regarding regulatory standards. We show that, on welfare grounds, the rule of NT performs relatively better under product standards, while MR is relatively more desirable under process standards. This result provides a welfare-based justification for adopting differential institutional rules on regulatory standards of different nature.