Environmental Certification Programs

This paper studies how information disclosed by voluntary environmental certification programs creates incentives for firms to invest in environmentally friendly process and production methods (PPMs). I develop a model with differentiated products and imperfectly informed consumers. Consumers care about the environmental characteristics of goods but cannot directly observe them. Firms differ in their ability to improve their PPMs, and have no incentive to do so absent government intervention or a program that provides information to consumers. A scheme of voluntary labels awarded to firms whose PPMs satisfy a chosen standard gives some firms enough incentive to invest to improve their technology. I use the model to explain how environmental certification programs improve consumer welfare and characterize the welfare maximizing labeling standard. Despite that taxation and regulation are more costly than certification because their compliance is mandatory, they yield greater social welfare due to their effectiveness in curtailing aggregate environmental damage.