On the Economics of Labels: How Their Introduction Affects the Functioning of Markets and the Welfare of All Participants

Abstract Are labels good or bad for consumers and firms? The answer may seem straightforward since labels improve information, yet economic theory reveals situations where their introduction reduces the welfare of at least some market participants. This essay reviews the theoretical literature on labels in order to identify and explain the main reasons that may cause labeling to produce undesirable side‐effects. In contrast to earlier reviews that either concentrate on narrow topics or treat the subject in a more or less informal way, we bring together the main results from all the relevant topics by presenting and discussing the assumptions and model‐building techniques that underpin them. The advantage of this approach is that it identifies the origin of the differences between results, thus allowing the synthesis of results that sometimes appear even to be contradictory. We focus on “quality labels” and examine the impact of labeling on market structure, the side‐effects of costly certification, issues related to the label's trustworthiness, the rationale for mandatory vs. voluntary labeling, the level at which the label's standard is set according to the agency that selects it, the political economy of labels, that is, pro‐ or anti‐label lobbying, lobbying to affect the label's standard, and lobbying in favor or against the label's mandatory imposition. These topics cover a wide range of applications, including Genetically Modified Organism (GMOs), organic produce, geographic indicators, controlled origin, eco‐labels, etc. We conclude by identifying topics that require further research.