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Article Excerpt
Abstract There has been a growing interest among policy makers on the use of information disclosure policies for pollution control. This paper theoretically assesses the consequences of information disclosure policies and identifies the conditions under which such policies are likely to bring environmental improvements. Based on a dynamic game framework, the paper shows that both eco-labeling and more general full information disclosure policies may not always result in pollution reduction. Full information disclosure policies are likely to be effective if the product is not heavily polluting and if the minimum quality standard is set quite low. The paper also identifies the conditions under which all consumers are strictly better off with information disclosure policies.
Keywords information disclosure * voluntary approaches * eco-label * pollution * asymmetric information
JEL Q50 * D80
Introduction
Increasing numbers of national and regional surveys show that consumers are willing to pay a premium for environmentally friendly products (Cairncross, 1992; Cason & Gangadharan, 2002; Kirchhoff, 2000; Wasik, 1996). In the presence of environmentally aware consumers, firms have incentives to produce environmentally friendly products in order to differentiate their products from otherwise similar products and command a price premium (Arora & Gangopadhyay, 1995). However, the environmental attribute of the product is known to only producers and consumers cannot typically evaluate the environmental claims even in repeated use. Because of this information asymmetry, firms have found it very difficult to credibly communicate their environmental performances. Thus, for green consumerism to be effective, government has an important role in providing consumers with credible information on the pollution profile of the products they potentially purchase (Pearce, Markandya, & Barbier, 1989).
In response to increasing green consumerism, a number of government-sponsored policies have been implemented which alleviate asymmetric information through disclosure of credible information about environmental quality of the product or pollution profile of firms. Among such policies, a famous example would be eco-labeling; a label is awarded if the products satisfy certification thresholds. Other policies include hazard information disclosures which inform consumers of the environmental hazards that could be caused by particular products (e.g., US EPA's Automobile Pollution Rankings), green electricity pricing in which customers pay a premium for electricity produced from renewable sources (Lamarre, 1997), and various government-sponsored voluntary programs in which participants (or products) are publicly recognized. These policies are not limited to OECD countries. For example, Indonesia's Program for Pollution Control, Evaluation and Rating (PROPER) publicly discloses environmental performance of domestic factories in a five-rating scheme.
Because of widespread popularity, information disclosure policies are called "the third wave of environmental policies" after direct regulations and market-based instruments (Tietenberg & Wheeler, 2001). Governments envision that information disclosure works as a cost-effective policy tool to complement or substitute existing regulatory tools. With information disclosure policies, firms can credibly communicate the environmental quality of their products and may have incentives to voluntarily employ environmentally preferred production methods beyond legal requirement in order to attract environmentally conscious consumers.
There are concerns, however, about their effectiveness in mitigating environmental externalities. Critics argue that information disclosure policies in general may not ensure adequate environmental protection since polluters will not be forced to make abatement efforts beyond minimum legal requirements with information disclosure itself (Gibson, 1999). Mattoo and Singh (1994) and Swallow and Sedjo (2000) raised concerns about eco-labeling. Using graphical analyses, they showed eco-labeling cannot only be ineffective but also cause an adverse effect on the environment. However, there is a paucity of formal empirical and theoretical analyses on the effectiveness of information disclosure policies in achieving the stated objectives.
This paper theoretically assesses the effects of information disclosure policies on the environment. The model employs a dynamic game framework in order to allow firms and consumers to behave strategically in response to the introduction of information disclosure policies. Using this model, I first analyze the effect of information disclosure policies, such as eco-labeling, that reveal binary information of whether the quality of the product is above a certain threshold or not. I then analyze more general disclosure policies that reveal full information about the quality of the product. In addition, I compare information disclosure policies with traditional regulatory tools. The paper then identifies the conditions under which information disclosure policies are likely to bring improvements in environmental quality and social welfare, and make policy recommendations based on the findings.
The author recognizes that these results may depend on the specific model and the assumptions used in the analyses, and this paper does not intend to "prove" these claims. Rather, it is intended to caution optimistic views that information disclosure policies will always improve environmental quality and to illustrate the rationale for caution. The main purpose of the paper is to make policy recommendations by identifying when and under what conditions information disclosure policies are likely to bring desirable outcomes.
The Model
The basic features of the model are modified from the quality differentiation literature (see, for example, Arora & Gangopadhyay, 1995; Bansal & Gangopadhyay, 2003; Ronnen, 1991 and Shaked & Sutton, 1982). Suppose there are only two firms in the industry, H and L. Firms produce a differentiated product in terms of the impact on the environment. Production generates a per unit pollutant D. There is an end-of-pipe cleaning technology that can reduce per unit pollutant to D-[e.sub.i], where [e.sub.i], measures the degree of cleaning, i=H, L. In what follows, I call [e.sub.i] an environmental quality of a firm's product. Each firm is assumed to offer only one quality of the product. Without loss of generality, I denote the firm that produces a higher quality product as firm H and the firm with a lower quality product as firm L. (1) Let [e.bar] > be the minimum environmental quality that firms' products are required to satisfy by the minimum quality standard. As is standard in the quality differentiation literature, firms are assumed to incur fixed costs that are dependent on environmental quality of the product and constant variable costs that are assumed to be zero for simplicity. Let firm H's and L's fixed cost functions be [C.sub.i] = C([e.sub.i]), i=H, L. The cost functions are assumed to be globally convex.
The formulation of the utility function follows that developed by Arora and Gangopadhyay (1995) and Bansal and Gangopadhyay (2003), both of which analyzed environmental policies in the presence of environmentally aware consumers. There is a continuum of consumers, indexed by [theta]. Each consumer demands at most one unit of the product and derives utility
U = [theta][e.sub.i]-[p.sub.i]-Z,
where [p.sub.i] is the price of the product of firm i, and Z is the aggregate level of pollution. Consumers...
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