Eco-labels and Free Riding
Peter E. Robertson*
School of Economics, University of New South Wales, Sydney, NSW, 2052, Australia.
September 2003
Abstract
This paper considers the behaviour of environmentally aware consumers in response
to the introduction of international eco-labelling programmes. The principle result is that,
for a global environmental resource, the equilibrium level of damage is independent of the
number of countries that have eco-labelling policies. This result highlights the potential
limitations of eco-labelling policies as a tool for environmental policy. In particular it
emphasises that eco-labelling policies may be undermined by fee-riding behaviour, since
they do not force consumers to internalize external environmental costs.
Keywords: Environmental policy; Trade policy; Eco-labelling; MEAs; Genetically
Modified Organisms, GATT; WTO.
JEL Classification: Q2; Q3; F00; H4.
* Tel. (+61) 29385 3367. Fax (+61) 92313 6337. Email p.robertson@unsw.edu.au. I am grateful for much
helpful advice from Chris Bruce, Arghya Ghosh, Hodaka Morita, Robert Hill, Nancy Olewiler, Bill
Schworm and John Piggott, and for the contributions of seminar participants at the University of New
South Wales and The University of Sydney.
1. Introduction
Over the last decade there has been a rapid expansion in national and international ecolabelling programmes. This has been due to not only the growing demand for
environmental conservation, but also a desire to improve and extend environmental policy
instruments. In particular, many environmental policies whether imposed unilaterally, or as
part of Multi-lateral Environmental Agreements (MEAs), violate the WTO’ principle of
non-discrimination. Since differential tariffs cannot be placed on “like products” defined
according to end use, WTO members cannot impose tariffs on goods that are produced in
an environmentally harmful manner.1.
In these situations eco-labelling has been regarded as a “market friendly” environmental
policy tool. A prominent example of this is the “dolphin-friendly tuna” program, which
was an explicit response to the GATT dispute between Mexico and the USA. Likewise
eco-labelling has been suggested as a solution to the USA’s recent failed attempt to ban
imports of shrimp that is harvested in a manner that prevents high mortality of endangered
sea turtles.2 Other examples include international forestry certification, which arose as an
alternative to boycotts and industrial action, over international trade in tropical
1 Under GATT Article XX WTO member countries may use trade measures to protect animal life and
exhaustible resources, (WTO 1998). However the interpretation of this article itself has been
controversial. In the “the shrimp-turtle dispute”, the Appellate Body of the WTO overturned a Panel
decision that found Article XX could not be invoked to justify trade restrictions based on Process
Production Methods (PPM) criteria. Even so, some observers argue that the conditions required to comply
with Article XX are so restrictive as to render it redundant, (Ranné 1999, Appleton, 1999).
1
hardwood,3 the use of eco-labels in endangered fisheries generally, Deere (1999). More
recently, there has been substantial debate over the regulation of transboundary
movements in genetically modified organisms (GMO’s). In particular labelling
requirements for foods have recently be tightened and extended by the EU, and many
countries including the EU have ratified the Cartagena Protocol on Biosafety, which
explicitly sets out labeliing requirements for exporting countries, (Mackenzie et al 2003,
Nielson and Anderson, 2000). Though this move has been widely applauded by
environmental lobby groups, significantly it is also seen as preparing a replacement policy
for the EU’s 5 year moratorium on imports new GM products, The Economist (2003).4
The purpose of this paper, therefore, is to evaluate the effectiveness of eco-labelling, with
particular attention to international eco-labelling programmes designed to limit the extent
of transboundary, or global environmental problems. The emphasis on transboundary
problems is particularly significant since with nation states, first best policy tools are
available for limiting environmental externalities. As the preceding examples show
however policies to remedy transboundary environmental externalities often conflict with
WTO rules. It is in this context that eco-labelling has been seen as an alternative to more
restrictive policies such as import bans. To investigate these issues we develop a model of
2 The tuna-dolphin dispute initiated the debate over the interpretation of GATT Article XX. For a
discussion of the use of eco-labelling of in the tuna-dolphin and shrimp-turtle disputes, see The
Economist, October 3, 1998.
3 For further discussion of tropical forestry certification schemes, see Swallow and Sedjo, 2000, Crossley
et al, 1997, and Simula, 1997.
4 A useful non-techncal overview of the current scientific debate over the effects of transboundary
movements in GMO’s is the recent UK government inquiry, GM Science review Panel (2003). According
to the repor the current limited range of GM crops, soyabeans, maize and cotton, pose little risk given
adequate monitoring and regulation. Nevertheless, the panel acknowledges that the risks may increase
substantially with the introduction of new crops (GM Science Review Panel 2003, p.23).
2
demand where consumers derive utility from the stock of an environmental good. The
model is designed to highlight the potential flaws in the use of eco-labels, and hence, while
being relatively simple, provides several stark results.
The principle result is that, in an equilibrium with eco-labelling, the level of environmental
damage is independent of a wide range of exogenous variables, including the number of
countries with the eco-labelling programme. Hence as the number of countries with ecolabelling increases, existing eco-label consumers of eco-labelled products can free ride by
reducing their own purchases.
The paper is organised as follows. Section 2 presents a model of consumer demand for a
commodity that has two production processes, one of which has a lower cost to the firm,
but generates a negative environmental externality. The equilibrium demands with and
without eco-labelling are discussed in Sections 3 and Section 4. Some policy implications
are discussed in Section 5 and Section 6 concludes.
2. A model of green consumerism
2.1 Commodities and the production process
A number of recent papers have highlighted different limitations of eco-labelling
programmes. First there are issues of the credibility of the label and the costs of
enforcement. Second there is the problem that the relevant information may simply be too
3
complicated to be incorporates on a label, or for consumers to comprehend.5 Third,
despite their increasing use, significant debate also exists over the potential misuse of
labelling requirements as a technical trade barrier, (WTO 1998a, WTO 1998b; OECD
1997).6
Little attention has been given, however, to the limitations of eco-labelling that might arise
due to free-riding behaviour by consumers. Free riding is likely when the information on
the label principally concerns the effects of the product on an environmental public good.
For instance forestry certification is designed to protect bio-diversity and carbon fixing
properties of rainforests. Similar arguments apply to eco-labelling schemes designed to
protect endangered species, such as sea-turtles.7
In order to sharpen the focus on these issues, I therefore consider a model where ecolabelling results in perfect information regarding environmental costs. I assume an
international economy with m consumers, and an environmental resource, R, which is a
public good. Let ciR be the consumption by consumer i, of a commodity that uses the
resource, R, as an input. The marginal depletion function for each consumer is R − c iR and
m
so the world consumption of the resource using commodity, is C R = ∑ ci . This good is
i =1
referred to below as the R–type good. I assume further that an alternative production
method exists. Thus there is a substitute good, the S–type good, that can be produced
5 Shams (1995), Kirchhoff (2000) and Mason (2001) discuss different aspects of the credibility and
enforcement and monitoring aspects of eco-labelling programmes.
6 This concern is heightened when the labelling information refers to process and production method
(PPM) criteria, since these may reflect differences in factor prices across countries.
4
without resource depletion. Let ciS denote the consumption the S–type good. For
instance, ciS and ciR may both refer to the consumption of shrimp products, but ciS refers
to shrimp that has been captured by trawlers fitted with turtle excluder devices.8
2.2 Consumers
Consumer preferences are described by a quasi-linear utility function
φi ( xi , ciR , ciS , R, C R ) = u i (ciR + ciS , R − C R ) + xi
where
xi
(1.)
the demand for a Hicksian composite commodity. The function
u i (ciR + ciS , R − C R ) is assumed to be strictly concave. Hence u i 1 > 0 , ui 2 > 0 , u i 11 < 0 ,
u i 22 < 0 , u i 11 u i 22 − (u i 12 ) 2 > 0 . In particular, since ui 2 > 0 , individuals derive utility
from the environmental resource and hence, some utility from avoiding consumption of
the R–type good.9 It is evident that each consumer’s contribution to aggregate resource
consumption, C R , may be very small. Nevertheless, as shown below, as long as it is
strictly positive, consumers will be willing to pay some small price premium for
environmentally friendly goods.
7 All but one species of sea turtle are currently threatened with extinction, Liebig (1999).
8 Note however, that WTO trade rules treat the S and R–type goods as a single good, and do not permit
discriminatory policies based on the different production process.
9 Thus we explicitly rule out “irrational” demands for the environment such as warm glow effects. These
would imply that consumers would take action to protect the environment even if they know their actions
have no environmental benefits. While such behaviour may exist to some extent, this would be a weak
behaviour rule on which to design policy tools.
5
Equation (1.) contains four structural assumptions that deserve further comment. First, the
quasi-linear form implies that commodity demands ciR and ciS are a small fraction of each
consumer’s total demand. Hence there are no income effects, and the prices of other
goods, xi , are unaffected by changes in this market. Second the size of the public good is
determined by the aggregate consumption of R–type goods. Third, the commodity
generates the same consumption utility, irrespective of the production process that is used.
Hence the first argument in the utility function is the sum of the consumption of both types
of the commodity. This assumption is inherent in the eco-labelling problem. For instance,
dolphin-safe and non-safe brands of tuna are identical from the point of view their taste.
Finally, because of this, (1.) only holds if there is full information. If there was no labelling,
so that consumers could not identify the environmentally friendly or non-friendly products,
then they will face an information constraint in attempting to maximise (1.). This
information constraint is discussed further in Section 3.
2.3 Firms
To focus on the impact of labelling policies on the demand side, it is useful to keep the
supply side as simple as possible. Specifically assume that there are many price taking
firms who supply ciR and ciS at a constant marginal cost, with the same technology. With
free entry this implies that the supply of both commodities is infinitely elastic at a price
equal to the marginal cost. It is convenient to refer to firms supplying c R as R–type firms,
and firms supplying c S as S–type firms, though a single firm may supply both types.
Production methods that result in resource depletion are assumed to be more costly than
6
methods that conserve the resource. Hence the price of the R–type commodity is less than
the substitute, p S − p R > 0 . For instance in the case of shrimp fishing methods, switching
turtle friendly substitutes is a matter of fitting turtle excluders at a cost of up to $US500
(Ranné 1999).10
3. Preliminary results
3.1 Global equilibrium without eco-labelling
If there is no eco-labelling, then consumers face an information problem in trying to
maximise (1.). They are concerned about the environmental impact of their consumption
choices, but cannot tell the R–type and S–type products apart. Since, firms will exploit this
information constraint if it improves profits, we have the following “lemons” result.
Proposition 1: In any country with no eco-labelling, only R–type firms exist and charge a
price p R . For all consumers in these countries, therefore, ciS = 0.
Proof: Without labels, all S–type firms sell at a price no less than p S . However, since
consumers cannot identify whether a product is from an S-type or R-type firm, R–type
10 The assumption of constant costs rules out some potentially perverse, but potentially interesting,
consequences of eco-labelling. Dosi and Moretto (1998) and Matoo and Singh (1994, 1997) explore these
possibilities further. Since the purpose of this paper is to analyse problems of eco-labelling schemes that
arise from consumer behaviour rather than producer behaviour, it is useful to assume a simple production
structure. Moreover, given the presence of eco-labelling polices in the agriculture, fishing and forestry
industries, it is arguable that a competitive setting is appropriate.
7
firms are able to realise profits by also selling at price p S . All S–type firms will therefore
maximise profits by converting to R–type firms and so there will be no S–type firms.
g
Hence under the assumption of no labelling there is no market for the S–type good.
Consumer i therefore chooses ciR to maximise (1.) subject to ciS = 0, and a budget
constraint. Due to trade restrictions and transport costs, consumers residing in different
countries may face different prices. The budget constraint is therefore y i = piR ciR + xi ,
where y i is income.
An equilibrium consists of m choices of ciR and ciS , that satisfy maximisation of (1.) by
each consumer, given the choices of the other consumers. Thus consumer i maximises
u i (ciR , R − ciR − C −Ri ) + y i − piR ciR
(2.)
m
taking C −Ri ≡ ∑ c Rj , as given.11 The first order condition for i is
j≠i
u i 1 (ciR , R − c iR − C −Ri ) − u i 2 (ciR , R − ciR − C −Ri ) − piR ≤0
(3.)
This says that individuals consume the resource until the marginal utility of the last unit
consumed is equal to the price plus the marginal dis-utility of the decline in the stock.
11 This could be thought of as a strategic decision in the sense that consumers must take into account the
aggregate behaviour of the other m-1 consumers. However it only implies that consumers condition their
choices on the expected aggregate level of R. Thus there is no sense in which we require each consumer to
strategically consider the actions of every other consumer. Nevertheless, in equilibrium, consumer
expectations must be correct. However there is no need to specify an adjustment mechanism that results in
equilibrium outcomes. Rather we merely use the concept of equilibrium as a point of reference to consider
how incentives change in the face of eco-labelling policies.
8
Since (1.) is strictly concave, (2.) is a strictly concave function of ciR , and (3.) describes a
unique maximum value of ciR for any value of C −Ri and R , and piR . Solving (3.) for ciR
therefore gives the demand function, ciR = ri (C −Ri , piR ) . Since this demand function is
conditional upon the aggregate level of environmental damage, in what follows it will be
convenient to refer to it as a reaction function.12
Proposition 2: With no eco-labelling, the consumer’s reaction functions are negatively
sloped in {ciR , C −Ri } space with absolute value between zero and one: − 1 < ∂ciR / ∂C −Ri < 0 .
Proof: See Appendix.
An equilibrium exists if the functions, (3.), intersect with ciR > 0 for some i. Moreover,
since p iR enters (3.) with a negative sign, then by the envelope theorem we have,
∂ciR / ∂piR < 0 .13 Hence a tariff or tax will shift the reaction functions toward the origin in
{ciR , C −Ri } space.14 Since the absolute slope of the reaction functions is less than one,
− 1 < ∂ciR / ∂C −Ri < 0 , any change in C −Ri will only be partially offset by a change in ciR .
Thus, in the absence of eco-labels, tax and tariff policies will: (i) reduce the equilibrium
level of environmental damage by consumers residing in those countries; (ii) increase the
12 Again it may be useful to emphasise that there is no real sense in which consumers are involved in
strategic games with all other consumers. Each individual must consider must only consider the aggregate
consumption of the m-1 other consumers.
13 This application of the envelope theorem is also known as the conjugate pairs theorem. It applies to
unconstrained maximisation problems, for any parameter that enters only one first order condition,
Silberberg (1974).
14 For a further discussion of the optimally of taxes and tariff policies, see Markusen (1975) and Kennedy
(1994).
9
equilibrium level of environmental damage by consumers in other countries, and; (iii)
reduce the overall equilibrium level of damage.
Thus it has been shown that when there are no eco-labels, there is no market for the safe
type good. In this setting, tax and tariff policies may be used to reduce environmental
damage. Given these preliminary results, I can now incorporate eco-labelling to see how
more information might affect consumption choices and the level of environmental
damage.
4. Eco-labels
4.1 Utility maximisation with eco-labels
To consider the effects of eco-labels, suppose that some consumers live in countries that
have perfectly enforced eco-labelling. These consumers, therefore, have full information as
to whether a commodity is produced by S or R–type firms. They choose ciR and ciS to
maximize (1.) subject to the budget constraint y i = piS ciS + piR ciR + x i . Hence consumer i
maximises
u (ciS + ciR , R − ciR − C −Ri ) + y i − piS ciS − piR c iR
(4.)
The first order conditions are
u i 1 (ciR + ciS , R − ciR − C −Ri ) − piS ≤0
(5.)
u i 1 (ciR + ciS , R − ciR − C −Ri ) − u 2 (ciR + ciS , R − ciR − C −Ri ) − piR ≤0
(6.)
10
If ciS > 0 , then (5.) holds with equality. Equating (5.) and (6.) gives
u i 2 (ciR + ciS , R − c iR − C −Ri ) − ( piS − piR ) ≥ 0
(7.)
Equation (7.) shows that the quantity of each good is chosen so that marginal utility of the
environmental resource, is equal to the price premium for the S–type good, piS − piR .
Using these first order conditions we have the following result.
Proposition 3: If (5.) and (6.) hold with equality, the reaction function
ciR = qi (C −Ri , piS , piR ) has a slope of negative one in {ciR , C −Ri } space: ∂ciR / ∂C −Ri = − 1 .
Proof: See Appendix.
Proposition 3 holds for a consumer who purchases both S–type and R–type goods. It is
useful to refer to such a consumer as a marginal consumer. Intuitively it means that if
some consumer increases consumption of R–type goods, marginal consumers will reduce
R–type goods by the same proportion. The fact that one or more consumers may have a
reaction function with a slope of negative one, therefore, has strong implications for the
equilibrium level of environmental damage.
Proposition 4: In an equilibrium where (5.) and (6.) hold with equality for at least one
consumer, the total level of damage is independent of the damage caused by any other
consumer who consumes positive quantities of environmentally unfriendly (R–type) goods.
Proof: See Appendix
11
For example let i denote a marginal consumer, and suppose there is an exogenous change
in C −Ri . From (5.) u i 1 (ciR + ciS , R − ciR − C −Ri ) = p iS , so that marginal utility for this
consumer must remain constant. This consumer therefore substitutes ciR and ciS so that
ciR + ciS and C R = C −Ri + ciR are constant. Thus Proposition 4 shows that the equilibrium
level of environmental damage is independent of all the exogenous variables that
determine the demands of all the other consumers. In particular any changes of
environmental policies in countries that do not have eco-labelling, and hence do not have
any marginal consumers, have no effect on the equilibrium level of world environmental
damage.15
4.3 Corner solutions.
To complete the model we must consider the existence of marginal consumers and also
the behaviour of non–marginal consumers, those who consume either no S–type goods, or
only R–type goods. Thus in this section we characterize these corner solutions.
Consideration of the corner solutions also facilitates a direct comparison between the
labelling and no eco-labelling situations.
First suppose that (5.) is not binding, so that ciS = 0 . In this case it can be seen that (6.)
reduces to (3.). Thus the reaction function for an arbitrary consumer i, must be the same
with and without eco-labels. Further, it can be shown that the point where (5.) becomes
binding is unique.
15 Moreover Lemma 1 in the proof of Proposition 4 shows that this result is a particular instance of a
more general result that holds whenever there is an additive externality and at least one agent has a
12
Proposition 5: For every consumer there is a unique point, ciR , such that ciS = 0 for all
ciR ≥ ciR and ciS > 0 for all ciR < ciR .
Proof: See Appendix
We may now consider the different regions of the reaction functions. First let all points
where ciR ≥ ciR be region (i). Since ciS = 0 in region (i), this is equivalent to the case
where there are no eco-labels. When 0 < c iR < ciR , (5.) and (6.) hold with equality, the
slope is ∂ciR / ∂C −Ri = − 1 . I denote this region (ii). Finally let region (iii) denote all points
where ciR = 0 . The three regions are illustrated in Figure 1. The curve a b g represents the
graph of {ciR , C −Ri } without eco-labels, and the curve a b λ is the reaction function with
eco-labels. From Proposition 4 and 5, they diverge at the point ciR .
Note further that in region (i), (6.) defines a unique value of ciR for every C −Ri . Hence
when (5.) holds with equality, it defines the unique coordinate { ciR , C −Ri }. Define the total
level of damage at this point to be λi = ciR + C −Ri . For any level of C iR ≤λi the consumer
chooses ciS = 0 . Hence λi is level of damage that just induces the consumer to purchase
S–type goods, given the prices piS , piR . Since the total level of damage is constant in
region (ii), then λi = C R at the point ciR = 0 also. Hence λi can be regarded as the
“maximum acceptable” level of damage for consumer i. That is, for any level of damage
reaction function with a slope of negative in all dimensions.
13
C −Ri , if C −Ri ≥ λi the consumer chooses ciR = 0 . The properties of each region are
summarised in Table 1.
Table 1: Regions of the reaction function.
CR
C−Ri
region (i)
C R ≤λi
C −Ri ≤λi − c −Ri
ciR ≥ c R , ciS = 0
region (ii)
C R = λi
λi > C −Ri > λi − c −Ri
ciR > ciR > 0 , ciR > ciS > 0
region (iii)
C R ≥ λi
C −Ri ≥ λi
ciR = 0 , ciS ≥ c R
ciR , ciS
4.3 Characterisation of an equilibrium in the presence of eco-labelling.
Since consumers are heterogeneous, a Nash equilibrium may have some consumers
choosing different levels of consumption.. If all consumers are in region (i), then the
equilibrium must be the same as in the no eco-labelling case. That is ciS = 0 for all i, and
the introduction of eco-labelling has had no effect. This is more likely if the price of the S–
type good is very high. If eco-labels are to have any effect on reducing environmental
damage levels, some consumers must be in region (iii) or (ii). From Propositions 3 and 5,
however, the demands in these regions must lie below the demands that would exist for
the same consumers if there were no eco-labelling. Hence
R
Proposition 6. For any consumer, i, the equilibrium level of consumption, ci , with eco-
labelling must be less than or equal to the level without eco-labelling. Thus the aggregate
14
level of damage under eco-labelling can be no higher than the level that exists without ecolabelling.
Despite this, the eco-labelling policy cannot deliver an optimal level of resource depletion.
Proposition 7. If there is more than one consumer, the level of environmental damage
under eco-labelling will exceed the optimal level.
Proof: See Appendix
Intuitively Proposition 7 holds because the eco-label has solved an information problem,
but not the public good problem. Since eco-labels do not force consumers to internalise
the external environmental costs of R–type goods, they do not result in an optimal level of
environmental damage. While this result is perhaps unsurprising given the structure of the
model, it points nevertheless to a common fallacy that labelling will enable consumers to
internalise all environmental costs.16
Finally, since Proposition 4 depends on there being a consumer in region (ii), it is useful to
consider the conditions for this to hold. To consider this issue, suppose all consumers who
reside in countries with eco-labels, are ordered according to their maximum acceptable
level of damage values, λi .17 Suppose further that there are n ≤m different values of λi ,
and let “type 1” refer to the group of consumers with the lowest value. Then
16 An example is calls for eco-labelling to resolve the shrimp-turtle dispute and the implementation of
ecolabelling as a resolution to the tuna-dolphin dispute. See for instance The Economist, 1998.
17 Since consumers may face different prices, consumers in each group need not be identical.
15
λ1 < λ2 < K < λn , where superscripts refer to consumer types. Using this definition of a
consumer type, I obtain the following result.
Proposition 8: In any pure strategy Nash equilibrium only one consumer type can be in
region (ii) where ciR ≥ 0 , ciS ≥ 0 .
Proof: See Appendix.
Hence if the marginal consumer type is type k, then in an equilibrium, any consumer types
j, where λj < λk will consume no R–type goods – region (iii) – and all consumers types j
where λj > λk , will consume no S–type goods – region (i).18
This is illustrated in Figure 2, for the special case n = 2. This shows consumers of type a
and b where λb > λa . Clearly region (ii) of each reaction function cannot intersect.
Further it can be seen that a’s reaction function can never intersect region (ii) of b’s
reaction function. Two possible equilibria are illustrated. If b’s reaction function is bλb ,
the equilibrium is e, with both consumers in region (i). The only other possibility for an
interior equilibrium is given by the reaction function b ′
λb . In this case the equilibrium is
18 An issue raised by Proposition 8 is that if there are only a few consumers of each type, then only a few
R
consumers can be in region (ii). In this case a large exogenous shock to C− i may force the marginal
consumers into region (i) or (iii). Thus Proposition 4 will only hold if there are a large number of
consumers of each type relative to the size of the exogenous shock considered. The model can be
generalised in an obvious way, however by considering the a distribution of consumer types. A note,
which is available on request, shows that any exogenous changes has little or no effect on the aggregate
level of damage if: (i) the number of consumers of each types is high, (ii) the density of types is high, or;
(iii), if the existing marginal consumer’s have high demand for the commodity, so that
relatively high.
16
∑
i
ciR is
. Consumer a is in region (ii) and b remains in region (i). A third possibility, not shown,
e′
is that the reaction functions do not intersect. In this case a will be in region (iii), and,
depending on the shape of its reaction function, b could be in region (ii) or (iii).
4.4 Discussion
Clearly the principle result in proposition 4 is very stark. In this subsection, therefore, I
briefly discuss the robustness of the results to alternative specifications of the model, and
how the Propositions 4 and 5 are related to other public goods models.
Proposition 4, highlights the implications of the free-riding. Nevertheless it depends on a
number of assumptions that are somewhat unrealistic. In particular it refers to equilibrium
outcomes. There has been no suggestion, however, that an equilibrium would actually be
observed, or that institutions exist to allow consumer behaviour to dynamically adjust
toward this equilibrium. This result therefore, should not be taken as a literal description
of potential outcomes, but simply as a point of reference for thinking about the incentives
created by eco-labelling policies.
It is also useful to consider briefly how robust the results are to the quasi-linear
specification of the utility function. This means that increments to income are spent
entirely on the Hicksian composite good, xi . The assumption is appropriate as long as the
commodity in question is only a small part of the consumer’s budget. This appears
reasonable when considering the examples discussed, such as tuna and shrimp products.19
If we were to adopt a more general specification than (1.), Proposition 4 would no longer
17
hold exactly, due to the presence of income effects. In particular, as shown in the
Appendix, if R is a normal good, then an exogenous increase in C−Ri , by reducing the
consumer’s net income, will cause the consumer to be less willing to substitute toward S–
type goods. In this case the slope of the marginal consumers reaction function will lie
between –1 and 0.
Nevertheless, if, as we would expect, income effects are small, then the slope of the
reaction function will be arbitrarily close to –1. Thus the specification preferences can be
seen as a useful simplification that sharpness the focus of the model on the potential for
free riding behaviour. Under very general conditions we may expect the world equilibrium
level of environmental damage to be unresponsive to exogenous changes, including
changes in the number countries with eco-labelling schemes.
Second, it is informative to consider the source of the neutrality result in relation to other
public goods results. It is well know that in the pure public goods model with quasi-linear
preferences, the total supply of a public good is independent of the number of subscribers,
Olson (1965).20 The present model, however is more complex. The R–type good is an
impure public “good”, since it not only affects the environmental stock, but also
contributes to private utility. Moreover, while (1.) specifies that utility is linear in the
19 See Vivas (1987) for a further discussion of the applicability of this assumption.
20 The result is derived from the fact that public goods externalities are additive. See Cornes and Sandler
(1996) for a full discussion. This result is different from another common neutrality result involving
income transfers, as discussed for example by Bergstrom, Blume and Varian (1986), and in an
environmental context by Copeland and Taylor (1995).
18
Hicksian composite good, it also specifies a completely general functional relationship
between the private good ciR + ciS and the public good R − C R .
Hence this eco-labelling model is very different from the pure public goods model.
Nevertheless a similar neutrality result holds due to the fact that: (i) the R and S–type
goods are perfect consumption substitutes so that consumption utility only depends on the
sum ciR + ciS , and; (ii) in equilibrium, their total demand is constant, due to perfect
competition on the production side of the model. Intuitively, by purchasing the S–type
good rather than the R–type good, consumers make a contribution to the environmental
resource at a constant cost equal to piS − piR . Since this “contribution” does not change
the sum ciR + ciS , it does not affect consumers utility except via the increase in the
environmental resource. Thus pure public goods neutrality result is retained, due to the
inherent structure of the eco-labelling problem.
5. Trade and Multi-lateral Eco-labelling Agreements
As discussed in the introduction, the WTO’s stance on process production method (PPM)
based trade measures, and recent deliberations over the interpretation of Article XX, have
made eco-labelling an apparently attractive policy option. The analysis herein has shown,
however, that under fairly general conditions world levels of environmental damage may
be insensitive to the number of countries that have eco-labelling programmes, even if there
is substantial consumer demand for these products.
19
For example, suppose the USA has an eco-label on shrimp sold in the USA. Consumers
who are purchasing turtle–friendly shrimp are, by definition, in region (ii) or (iii) and have
values of λ greater than or equal to the current equilibrium damage levels. Other
consumers may be purchasing only cheaper brands that do no have the eco-label, region
(i), or simply not purchasing shrimp at all.
Next suppose a MEA protecting sea turtles, or an environmental clause in a trade
agreement, is introduced so that consumers in other countries may now choose to
consume turtle–friendly shrimp. Propositions 4 and 9 suggest that the US consumers who
initially consume turtle–friendly shrimp, will now have a greater incentive to consume the
non–friendly variety. This substitution occurs on a one–to–one basis, and so multilateral
eco-labelling may have very little or no affect on the mortality rate sea turtles.
The model also sheds light on consumer awareness surveys that show that consumers
willingness to pay for the German Blue Angel eco-label, declined significantly during the
last decade, OECD (1997).21 As shown in Table 1, this decline in German consumer
demand corresponds with a rapid growth of eco-labels in other countries.22 It is not
unreasonable to suppose that, as implied by proposition 4, some of the decline in demand
was due to an awareness of increasing consumer demand for environmentally safe goods
in the rest of the world.
21 The survey’s were conducted by the Federal Environment Ministry of Germany. They show that
Germany’s Blue Angel eco-label was extremely successful when it was introduced in 1977. Consumer
support fell between 1992 and 1996, and between 1994 and 1996, willingness to pay more for Blue Angel
products declined from 59% to 35% in West Germany and from 24% to 17% in East Germany (OECD
1997, p.60).
22 The OECD (1997) attributes this to consumer confusion due to the proliferation of different labels.
20
Table 1: The Evolution of Regional Eco-Labelling Programmes
Programme
Country
Number of Number of
Product
Products
Groups, 1996 in 1996
Blue Angel
Environmental Choice
Nordic Swan
Eco-Mark
Good Green Buy
Green Seal
Environmental Choice
Environmental Choice
Ecomark
NF Environment
Austrian Eco-label
Ecomark
Green Label Singapore
Stichting Milieukeur
EU Eco-Label Award
Environmentally Friendly
Germany
Canada
Finland, Sweden, Iceland, Norway
Japan
Sweden
USA
New Zealand
Australia
India
France
Austria
Rep. Of Korea
Singapore
Netherlands
European Union
Croatia
75
48
45
71
27
19
3206
1600
> 1000
2023
695
318
5
200
11
24
Date
Introduced
1977
1988
1989
1989
1990
1990
1990
1991
1991
1991
1991
1992
1992
1992
1992
1993
Source: OECD (1997), Vossenaar (1997).
The model also suggests that multilateral eco-labelling has interesting implications for the
pattern of trade. In the preceding examples, USA shrimp consumers and German Blue
Angel consumers will increase the aggregate national demand for cheaper non–safe
brands. Thus a country that exports non–safe commodities, for instance a country that
endowed tropical rainforest but no plantation forestry, may experience in increase in
export demand from countries that have marginal consumers in the initial equilibrium – for
instance USA and Germany in the examples above.23 Moreover model implies that the
incentives for producers of S–type goods to lobby for import barriers against
environmentally unsafe, R–type, goods will be greatest when many other countries also
have similar eco-labelling programmes.
21
A tariff, or any other policy that affects the prices of the safe and non-safe commodities,
can reduce global environmental levels, according to Proposition 4, as long as it alters the
prices faced by marginal consumers. Thus, in the examples above, Germany or the USA
could prevent the increase in demand for non–safe brands by imposing taxes and tariffs in
response to the adoption of eco-labelling by other countries. In this case, however, the
eco-labelling policy itself is essentially redundant. Likewise, it can be seen that a MEA that
removes PPM tariffs between member countries, but at the same time extends an ecolabelling scheme to all member countries, is likely to result in an increase in damage levels.
6. Conclusion
Since a number of recent trade–environment disputes have failed to meet the WTO’s
requirements for exemptions, the use of eco-labels has attracted increasing interest from
environmental and free trade lobby groups. This paper has analysed a partial equilibrium
model of consumer demand for a commodity that can be produced using environmentally
safe or harmful methods. In this setting, the public good aspect of environmental
conservation means that consumers attempt to free-ride on other consumers’ purchases of
safe brands.
The principle result concerns the behaviour of consumers who purchase environmentally
friendly brands. In response to an exogenous change in the level of environmental damage,
23 For example consider a country that endowed tropical rainforest but no plantation forestry. Such a
country may be a developing country, though as shown by Antweiler, Copeland and Taylor (2001), it is
not necessarily the case that low income countries export pollution intensive goods.
22
these consumers will face incentives to increase or reduce their purchases of the
environmentally friendly and unfriendly goods.
The model shows that, for marginal consumers, this substitution occurs on a one–to–one
basis. The behaviour of these consumers means that the equilibrium level of world damage
may be constant. Conditions were derived under which the level of damage will be
independent of a range of exogenous variables, including the number of countries with
eco-labelling policies.
While the model is not intended to be a literal description of consumer behaviour, it does
nevertheless highlight the potential limitations of eco-labelling programmes. In particular
they raise doubts over the merits of multilateral environmental agreements that promote
eco-labelling, and suggest that eco-labels are likely to be a poor substitute for more
mandatory policies, that force consumers to internalise environmental costs.
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Appendix
Proof of Proposition 2
For this proof I use the first order condition,
u i 1 (ciR , R − ciR − C −Ri ) − u i 2 (ciR , R − ciR − C −Ri ) − piR = 0
27
(3.)
This is an implicit function of ciR . A necessary condition for an interior equilibrium is that
this implicit function satisfies − 1 < ∂ciR / ∂C −Ri < 0 . Differentiating (3.), but holding price
constant, gives
u i 11 dciR − u12 (dciR + dC −Ri ) − u i 21 dciR + u 22 (dciR + dC −Ri ) = 0
(8.)
rearranging gives
∂ciR
− (u 22 − u12 )
=
R
∂C − i (u11 + u 22 − u12 − u 21 )
Since u 22 − u12 < u11 + u 22 − u12 − u 21 this implies − 1 < ∂ciR / ∂C −Ri < 0 .
(9.)
g
Proof of Proposition 3.
For some consumer i, the first order for ciS is
u i 1 (ciR + c iS , R − ciR − C −Ri ) − piS = 0
(5.)
Differentiating, but holding piS constant, and solving for dciS gives
u i 11 (dc iR + dciS ) − u i 12 (dciR + dC −Ri ) = 0
dciS = (u i 12 / u i 11 )(dciR + dC −Ri ) − dciR
(10.)
Next recall that combining (5.) and (6.) gives
u i 2 (ciR + ciS , R − ciR − C −Ri ) = p iS − p iR
28
(7.)
Differentiating (7.) gives
u i 21 (dciR + dciS ) − u i 22 (dciR + dC −Ri ) = 0
(11.)
Using (10.) to substitute out dciS gives
u i 21 (dciR + u i 21 ((u i 21 / u i 11 )(dciR + dC −Ri ) − dciR ) − u i 22 (dciR + dC −Ri ) = 0
(12.)
Simplifying
((u i 21 ) 2 / u i 11 − u i 22 )(dciR + dC −Ri ) = 0
(13.)
The second order condition for a maximum is u i 11u i 22 − (u i 21 ) 2 > 0 . Hence since
u i 11 < 0 , it follows that ((u i 21 ) 2 / u i 11 − u i 22 ) > 0 . Thus, whenever (5.) and (6.) hold with
equality dciR + dC −Ri = 0 , or equivalently, ∂ciR / ∂C −Ri = − 1 .
g
Proof of Proposition 4.
Proposition 3 shows that for any consumer who is in an interior equilibrium, the reaction
function has a slope of negative one. Given this, Proposition 4 follows from the fact that
each consumer only derives utility from the total aggregate level of the resource. To see
this consider the following Lemma.
Lemma 1: Consider any reaction function than can be written xi = f ( ∑ x − i ) , where ∑ x − i
is the sum of all other consumer’s actions. Suppose, further, that for some agent j,
x j = A − ∑ x − j , where A is a constant. That is, one agent has a response function that has
29
a slope of negative one. Then in an equilibrium where x j > 0 , the equilibrium value of xi
is independent of x k for all i and k, where k ≠ i . Hence dxi / dx k = 0 for all k ≠ i .
Proof of Lemma 1: The proof follows from the definition of a Nash equilibrium in pure
strategies. First we write the reaction function of an arbitrary agent i as
f (∑ x − i ) ≡ f (∑ x − i − j + x j ) . The term ∑ x − i −
j
refers to the sum of all actions except those
of agents i and j ≠ i . Given that x j = A − ∑ x − j , a necessary condition for a Nash
equilibrium is that xi solves xi = f (∑ x − i − j + A − ∑ x − j ) = g ( x j ) . Hence in equilibrium, the
value of xi is independent of the actions of all other agents except j, for all i.
g
Proposition 4 follows directly from Lemma 1. First note that any consumer i for whom
ciR > 0 and C −Ri ≠ 0 , is in an interior equilibrium. Thus, if there is exist at least one
marginal consumer, j such that c Rj > 0 and c Sj > 0 , then every other consumer i, for
whom ciR > 0 , where i ≠ j , is in an interior equilibrium. That is, all consumers who
consume R–type goods are in an interior equilibrium. Lemma 1 shows that the actions of
these consumers only affect the demand of the marginal consumer. From Proposition 3,
however, the marginal consumer will respond by increasing or reducing c Rj to offset this
exogenous change, since that agent’s reaction function has a slope of negative one.
Therefore the aggregate level of environmental damage is independent of the demand for
R–type goods by all other consumers who are in an interior equilibrium.
30
g
Proof of Proposition 5.
Suppose equation (5.) is not binding. Then we have u i 1 (ciR + ciS , R − C −Ri − ciR ) < piS and
ciS = 0 . That is, the marginal utility of consumption of S–type goods is less than its price.
It can be shown, however, that u i 1 (ciR , R − C −Ri − ciR ) is increasing for points on the
reaction function, qi (C −Ri , piS , piR ) , with lower values of ciR and higher values of C −Ri .
Hence, for lower values of ciR , eventually either (5.) becomes binding and ciS > 0 , or
ciS = 0 everywhere for this consumer. Denote the point where (5.) becomes binding as
ciR . Then ciS = 0 for all ciR ≥ ciR . Further at the point ciR , since (5.) is binding, marginal
utility of consumption is constant u i 1 (ciR + ciS , R − C −Ri − ciR ) = p iS . Therefore ciS > 0 for
all ciR < ciR .
It remains therefore only to prove the assertion that marginal utility of consumption
u i 1 (ciR , R − C −Ri − ciR ) increases as we move down the reaction function qi (C −Ri , piS , piR )
with lower values of ciR . Note that this does not follow directly from the fact that
u i 11 < 0 , since along the reaction function C −Ri is not constant.
First differentiate u i 1 (ciR , R − C −Ri − ciR ) with respect to C −Ri , to obtain
u i 11 (dc iR / dC −Ri ) − u i 12 − u i 12 (dciR / dC −Ri )
(14.)
It is necessary to show that this expression is positive. From the proof of Proposition 2 we
have
31
− (u i 22 − u i 12 )
dc iR
=
R
dC − i u i 11 + u i 22 − u i 12 − u i 21
Substituting this into (14.) and simplifying gives
u i 11u i 22 − u i 12
u i 11 + u i 22 − 2u i 12
2
−
(15.)
The denominator of this expression is negative and further, since u i 11 u i 22 − (u i 12 ) 2 > 0 ,
g
the expression is positive as required.
Proof of Proposition 7
Although it has been shown that perfect eco-labels can reduce the level of environmental
damage, it remains to demonstrate that the equilibrium is socially inefficient. To see this I
consider the optimal consumption allocation of a planner, whose objective function is
W = ∑ u i (ciS + ciR , R − C R )
(16.)
i
The planner maximises this subject to a set of resource constraints. Since perfect
competition has been assumed, firms set price equal to marginal cost the planning problem
can be written as equivalent to maximising
∑ u (c
i
S
i
+ ciR , R − C R ) +
i
∑ (y
i
32
i
− p iR ciR − piS ciS )
(17.)
with respect to ciS and ciR , for all i. The assumption that the prices may differ across
countries is retained for ease of comparison. Moreover this may reflect transport costs
across countries. The first order conditions for an interior equilibrium are
u i 1 (ciS + ciR , R − C R ) − p iS = 0
u i 1 (ciS + ciR , R − C R ) −
∑
u i 2 (ciS + c iR , R − C R ) − p iR = 0
(18.)
(19.)
i
The first condition (18.) is consistent with the market solution (5.). Equation (19.)
however is a version of Samuelson’s condition for the optimal provision of a public good
and differs from the market solution given by (6.). The two conditions coincide only if
m = 1, or if p S − p R = 0 . For m > 1,
∑u
i2
(c iS + ciR , R − C R ) must be smaller in the
i
planner’s solution compared to the market solution, when all consumers consume some S–
type goods. Thus the average value of u i 2 (ciS + ciR , R − C R ) must be lower in the planners
solution.
Thus, if d (u i 2 (ciS + ciR , R − C R )) < 0 , implies dC R < 0 , then the planning solution must
have a lower level of total environmental damage, C R .Evaluating the expression
d (u i 2 (ciS + ciR , R − C R )) gives u i 21 (dciS + dc iR ) − u i 22 dC R < 0 . Further, differentiating (5.)
gives dciR + dciS = (u i 12 / u i 11 )dC R . Substituting to eliminate the term dciR + dciS gives
((u i 21 ) 2 / u i 11 ) − u i 22 )dC R < 0 . Hence dC R < 0 if ((u i 21 ) 2 / u i 11 ) − u i 22 ) > 0 . This is
33
satisfied since, from the second order conditions, u i 22 u i 11 − (u i 21 ) 2 > 0 Since u i 11 < 0 ,
dividing both sides by u i 11 gives ((u i 21 ) 2 / u i 11 ) − u i 22 ) > 0 , as required.
g
Proof of Proposition 8
Consider an equilibrium where C −Ri = λi . Consumer i will be in region (ii) and, from the
definition of λi , will choose ciR = 0 , so C −Ri = λi = C R . The first order condition (5.)
becomes
u i 1 (ciS , R − C −Ri ) = p iS
(20.)
The left hand side is strictly decreasing in ciS and so this defines a unique maximum value
of ciS . Denote this ciS = f ( R − C −Ri , piS ) . Then (7.) becomes
u 2 ( f ( R − C −Ri , piR ), R − C −Ri ) = piS − piR
(21.)
This defines a unique level of C iR = C R and, therefore also, a unique value of λi . Thus, if
(21.) holds for some consumer type λk = λi , it cannot also hold for another type. Hence
only one consumer type can be in an interior equilibrium.
g
Income Effects
In this appendix I consider the implications of a more general specification of the utility
function than the quasi-linear form, (1.). Specifically suppose that consumer i maximises
34
φi ( xi , ciR , ciS , R, C R ) = u i (c iR + ciS , R − C −Ri − ciR , xi )
(22.)
subject to y i = piS ciS + piR ciR + x i . Using this budget constraint to substitute for ciR , and
recalling that C R = C −Ri + ciR , we have
C R = C −Ri + y i / piR − ( piS / piR )ciS − xi / p iR .
(23.)
From this it can be seen that for any exogenous shock dC −Ri , there is some value dy * that
could induce no change in C R and hence leave total utility unchanged. Note that this
implies that dC −Ri = dciS = − dciR . The income compensation required satisfies
dC R = dC −Ri + dy * / piR − ( piS / piR )dc iS = 0
(24.)
Substiuting dC −Ri = dc iS and solving gives dC −Ri (1 − p iS / p iR ) = − dy * / piR and hence
dC −Ri ( piS − piR ) = dy *
(25.)
Thus if income increases by exactly this amount, the consumer’s utility remains the same.
Consequently an exogenous change in damage levels, dC −Ri has the same effect on total
damage, C R , as a decrease in exogenous income ∂y * /( piS − piR ) . Hence
∂C R / ∂C −Ri = − ( piS − piR ) ∂C R / ∂y *
35
(26.)
Next consider the consumer’s reaction function. This can be written as a function of all the
exogenous variables,
qi (C −Ri , piS , p iR , y ) . Hence total resource consumption is
C iR = C −Ri + qi (C −Ri , p iS , piR , y ) . Differentiating this to evaluate (26.) gives
∂ciR / ∂C −Ri = − 1 − ( piS − piR ) ∂ciR / ∂y *
(27.)
This is a Slutsky-type decomposition of the reaction function, showing the compensated
substitution effect, -1, and the income effect of a change in C −Ri . In the main text, the
quasi–linear preferences give ∂ciR / ∂y * = 0 , so that ∂ciR / ∂C −Ri = − 1 . If the environmental
resource is normal and the R–type commodity is inferior, so that ∂ciR / ∂y * < 1 , the slope
of reaction function will be between 0 and –1. Nevertheless, it can be seen that as long as
∂ciR / ∂y * , is small, then the slope will be approximately –1, and the analysis in the text
therefore provides an appropriate and useful simplification.
36
Figure 1
ciR
a
ciR
(i)
b
(ii)
(iii)
λi − ciR
37
λi
g
C −Ri
Figure 2
c aR
λb
λa
a
e
e'
b'
b
38
λa
λb
cbR