Do Food Labels Make a Difference?...Sometimes

There is a lot to know about the food we eat. The ingredients in a jar of spaghetti sauce, a box of cereal, or a cup of coffee could come from around the corner or around the world; they could be processed by children or by high-tech machines; they could be grown on huge corporate farms or on small family-run farms; or they could be mostly artificial or 100-percent natural.

While a description of a food product could include information on a multitude of attributes, not all of them are important to consumers or regulators. Information on some attributes could affect the health and welfare of consumers by influencing their food choices. Information on other attributes might have no effect at all.

Consumers, food companies, third-party entities, and governments play a role in determining which attributes are described on the label. The interaction of these groups influences which information is labeled voluntarily, which is mandated, and which is not labeled at all. It shapes the way information is presented and the accuracy and credibility of that information. The economics behind food labeling provides insight into the dynamics of voluntary food labeling and the types of market failures best addressed through mandatory labeling requirements.

Companies Will Voluntarily Label If Their Benefits Outweigh Their Costs

Voluntary labeling is one of a foodcompany’s many advertising options.Assuming that companies attempt to maximizeprofits, they will add informationabout an attribute to the label as long aseach additional message eventually generatesmore benefits than costs. The primarybenefits of labeling for a companycome from either increasing profits ormaintaining profits in the face of newcompetition. Either outcome is more likelyif consumers use the information to differentiatethe labeled product from similarproducts and then buy it.

The probability that consumers willvalue and react to labeled information isimproved if the label successfully persuadesconsumers that it conveys informationabout a meaningful distinctionbetween labeled and unlabeled products.If consumers decide that the information’ssignificance or accuracy is questionable,they will not use it to modify theirpurchase decisions. Researchers from theUniversity of California and ERS found,for example, that the geographic brandingof Washington State apples is losing itsimpact because it does not convincinglydifferentiate the State’s apples from thosegrown in other areas.

To bolster the meaningfulness oftheir message, firms often rely on advertisingand other types of outreach. In2005, the U.S. food industry spent $32 billionon advertising and $66.5 billion onpackaging to differentiate their productsfrom the competition (see “Food Product Introductions Continue To Set Records” ).

Firms may also try to convince consumersof the validity of their labelingclaims by using third-party labeling services.By offering an “unbiased” assessmentof a labeling claim, these services helpstrengthen the credibility of voluntarylabeling (see box, “Third-Party LabelingServices Can Improve Market Efficiency”).A number of entities, including consumergroups, producer associations, privatecompanies, national governments, andinternational organizations, provide thirdpartyservices. The Good HousekeepingInstitute, for example, founded for thepurpose of consumer education and productevaluation, sets product standards andprovides consumer guarantees for a multitudeof goods, including foods. Two privatecompanies, Société Générale deSurveillance (SGS) and AIB International(originally the American Institute ofBaking), verify and certify food safety for awide range of food products. USDA’sAgricultural Marketing Service (AMS) hasdeveloped official grade standards formeats, eggs, poultry, dairy products, freshfruits, vegetables, tree nuts, peanuts, andother commodities. ISO, a worldwide federationof national standards institutes, promotes the development of internationalstandards for a variety of products andproduction processes.

The value of the labeling service generallydepends on the credibility and reputationof the providing entity. In somecases, national governments or associationsof national governments may be themost widely recognized and reputablethird-party providers of labeling services.But this is not always true. For example,although U.S. consumers tend to have confidencein USDA and the Food and DrugAdministration (FDA) to regulate foodsafety, Europeans rank national bodies farbelow international, environmental, consumer,and farm organizations in terms oftrustworthiness.

Private and government labeling serviceshave helped support an explosion ofvoluntary food labeling. American grocerystore shelves have become veritable encyclopediasof labeling claims. A single cartonof eggs sold in a national grocery storechain, for instance, is labeled with a “cagefree” claim, the grocery store “quality andsatisfaction money-back guarantee” logo,the Orthodox Union symbol of kosher certification,and a long list of nutrientclaims, including “25% of the daily valueof vitamin E; 185 mcg of lutein per egg;and 100 mg of omega-3 polyunsaturatedfatty acids per egg.”

A byproduct of the explosion oflabeled attributes is that consumers learnto “read between the labels” and makedeductions about unlabeled products. Forexample, confronted with one can of tunalabeled “dolphin friendly” and one withno such claim, consumers would likelyassume that the unlabeled tuna wascaught with dolphin-endangering practices.In a competitive marketplace, thepresence of a label is a signal of quality,and the lack of a label on competingbrands implies the absence of the qualityattribute.

Consumers’ ability to make inferencesabout quality further spurs the proliferationof labels. Companies in a competitivemarketplace are motivated tomake explicit claims for all positive “sellable”product attributes since they knowthat consumers may interpret the lack oflabeling as a lack of the attribute. It isalmost impossible, for example, to find acan of tuna in the United States without adolphin-friendly label.

Ultimately, the company’s bottomline sets limits on product differentiationand labeling. Not all attributes are worththe cost. “Predator-friendly” labeling, acampaign to promote wolf-friendly cattleranching, has not had the success of thedolphin-friendly label. Likewise, “Made inAmerica” or similar country-of-originlabeling is not always a valuable marketingattribute. Only if consumers believe thatfood produced in the United States is tastier,safer, or has some other distinctiveattribute will the label be worthwhile tomanufacturers or retailers. A company’sbenefit-cost criterion for deciding whichinformation to include on the label helpsensure labeling efficiency. Only informationvaluable enough to consumers to justifythe cost is included on the label.

Voluntary Labeling May Leave Information Gaps

Economic theory predicts that voluntarylabeling is not always sufficient fordisclosing information on all attributesconsumers value or for guaranteeing informationaccuracy. One limitation to voluntarylabeling may arise when an entireproduct category has an undesirable characteristic.In these cases, manufacturersdo not compete on the attribute and thereforedo not provide labeled or otherwiseadvertised information to consumers. Forexample, there was little information onthe sodium content of processed foodsbefore manufacturers were required todisclose it. The competitive process didnot work well to reveal high-sodium products;few manufacturers competed to offerreduced-sodium products because less ofthis “health negative” attribute also tendsto reduce taste.

Another limitation to voluntary labelingarises because manufacturers may provideonly relative information. For example,a sausage label may boast “30 percentless fat than the leading brand” or a baconlabel may brag “half the sodium.”Although this type of information is valuablefor deciding among competing brandsof the same item, it is not complete. Lowerfat sausage may still be a high-fat food. Inmany cases, consumers need informationon absolute, not just relative, values tomake fully informed consumption decisions.

Market forces may also be unable toeliminate partial disclosure and innuendo.For example, in early 2000, a manufacturerbegan marketing a wheat-flake cerealwith a label proclaiming no “geneticallyengineered ingredients.” A consumeradvocacy group asked the FDA to takeenforcement action against the manufacturer(and six others) on the grounds thatthe labels were misleading because theyimplied that the absence of genetically engineered ingredients distinguished theproduct from competing brands, whenactually, no genetically engineered wheatis present in any food. The manufacturerremoved the label.

Mandatory Labeling Has Targeted Information Gaps and Social Objectives

U.S. Government intervention inlabeling began in 1906 with the FederalPure Food and Drugs Act and the FederalMeat Inspection Act, which authorizedFederal regulation of the safety and qualityof food and prohibited sales of misbrandedor adulterated foods. Lawmakers’primary objective in passing the acts’labeling regulations was to enhance faircompetition by cracking down on deceptivemarketing practices.

Enhancing fair competition and marketefficiency has remained a primarymotivation behind food labeling regulationfor the past 100 years. Regulationsranging from the 1966 Fair Packaging andLabeling Act (requiring all consumer productsin interstate commerce to containaccurate information to facilitate valuecomparisons) to the Organic FoodsProduction Act 1990 have sought to createa level playing field for producers by providingconsumers with accurate informationfor comparing products and makingchoices. These regulations seek to increaseinformed consumption, not toalter consumptionbehavior. USDA’s NationalOrganic Program (the result of the OrganicFoods Production Act) is designed toimprove the comparability of organiclabeling claims, not persuade more consumersto choose organic products.

Recently, government intervention inlabeling has begun to target environmentalor other spillovers associated with foodproduction and consumption. Individualfood consumption decisions can havesocial welfare consequences, includingeffects on the environment, health andproductivity, labor conditions, and farmand industry structure. For example,consumers who eat tuna caught withencircling nets may inadvertentlyendanger dolphins.Economists describe these kinds of situations,in which the action of one economicagent affects the well-being or productionpossibilities of another in a waythat is not reflected in market prices,as externalities.

When private consumption decisionsresult in externalities, social welfare maybe maximized by a labeling choice that differsfrom one generated by private firms.In the tuna example, the potential benefitsof providing information on labelsinclude fewer dolphin deaths. For societyas a whole, these potential benefits mayoutweigh the increase in profits that composea private firm’s labeling benefits. Asa result, the social benefits of labeling mayoutweigh the social costs even though theprivate benefits do not outweigh privatecosts. The opposite could also be true. Forexample, the increased consumption ofred wine resulting from labeling red winewith the information that moderate consumptionmay lower the risk of heart diseasecould result in higher costs frommore birth defects, car accidents, and alcohol-related health costs. These social costsmay outweigh the benefits of reduced heartdisease.On the otherhand, the firm’s net benefits may be positive:the costs of redesigning labels couldbe lower than the benefits of increasedsales triggered by the health claim.

In externality cases where privatefirms do not supply relevant information,the government may decide to intervenein labeling decisions to try to maximizenet social benefits. Government-mandatedlabeling can be a useful tool for achievingsocial objectives because of the potentialpower of information to influence consumptiondecisions. However, economictheory suggests that labels may be a poormeans of addressing problems of externalitiesand advancing social objectives,such asprotecting consumer health or the environment.Even if some consumers altertheir behavior to account for externalitycosts, others do not, which means that theobjective will probably not be met. Forexample, while some may purchase onlyfree-range chickens, their goal of endingchicken cooping will not be achieved aslong as most consumers continue to buychickens raised in coops.

Economic theory identifies a numberof policy tools that may be more suited toredressing externalities than informationremedies. Bans, quotas, production regulationsor standards, and Pigouvian taxes(which impose the externality cost of anactivity on its producer) may be more successfulthan mandatory labels in adjustingconsumption and production to bettermatch socially optimum levels.

Empirical studies have found mixedresults on the efficacy of labels in educatingconsumers and changing consumptionbehavior. These studies highlight theobservation that consumers often makehasty food choices in grocery stores andusually do not scrutinize food labels.Researchers from Purdue University andthe Ecole Nationale Superieure de GenieIndustriel in France found that most participantsin a marketing experiment didnot notice the “GMO” (genetically modifiedorganism) label on a food productuntil the label had been projected in largeletters on a big screen.

Research also shows that a largenumber of warnings or a list ofdetailed product information maycause many consumers to disregardthe label completely. And, even if consumersdo consider each piece of informationon a label, they may find it difficult torank the information according to importance.For example, out of 10 warnings ona label, consumers may have difficultypicking out the most important. As aresult, consumers may underreact toimportant information or overreact to lessimportant information.

Labels May Influence Producers More Than Consumers

The primary impact of mandatorylabeling regulations may stem from theireffect on product reformulation and innovation,not on consumers’ food choices.Changes in labeling regulations can openup areas of competition by allowing producersto compete on a new set of attributes,like health claims. To compete inthese new areas, manufacturers mayintroduce new or reformulated products.Economists at the Federal TradeCommission found that regulation allowinghealth claims on cereal boxes resultedin significant product innovation anda plethora of cereals claiming tohelp reduce the risk of cancer. Newlabeling requirements can also spurproduct introductions or reformulations.Firms that are forced to disclose the negativecharacteristics of their products maychoose to reformulate rather than risklosing sales from disclosure.

Manufacturers’ reactions to labelingpolicy could be quite swift. In an effort tobe the first to label—and capture firstmoverprofits—manufacturers may reformulatebefore consumer demand kicks in.FDA researchers found that leading up tomandatory trans fat labeling, most consumersdid not know whether trans fatswere good or bad. Nevertheless, in anticipationof mandatory labeling, manufacturersquickly jumped on the “no trans fat”bandwagon. From January 2005 through the first 9 months of 2007, manufacturersintroduced 5,459 products with labelingtouting low or zero trans fat content.

Manufacturers may label and reformulateeven though most consumers arenot particularly interested in the newattribute. Sometimes a small niche groupof consumers is enough to warrant theexpense of reformulation and productinnovation, particularly when the newingredient or attribute does not affecttaste or price and therefore does not alienatecore groups of consumers. The moreattributes manufacturers can stack in theirproducts—eco-friendly, low-sugar, fairtrade,high-fiber—the more niche consumersthey may be able to attract.

As a result of product reformulation,labeling regulation can affect consumerfood choices more than would have beenaccomplished simply via consumers’ reactionsto labels. Even consumers whoremain indifferent to or unaware of a newattribute may consume more of it if theirusual food choices have been reformulated.For example, some consumers of popularsnack foods may not know that theirfavorite nibbles are now made withouttrans fats. They are reaping the benefits ofa potentially more healthful diet withoutchanging their food choices. However, ifthe price of their favorite snack risesbecause of reformulation, consumers whodo not want the new attribute are madeworse off.

The benefits and costs of labeling regulationcould be far reaching when manufacturersrespond by reformulating. Ashift to “zero trans fat” has triggeredchanges all along the processed foodchain, including investments in new processingtechnologies and the developmentof soy and canola crop varieties with differentoil characteristics. Other reformulationscould have ramifications for theenvironment, animal welfare, and consumers’health and budgets.

These cases stand in stark contrast tothose in which labels go unread and unnoticed.They also underscore the potentialof labeling policy that works with industryincentives to affect the content andquality of American diets.

Third-Party Labeling Services Can Improve Market Efficiency

Third-party labeling services—services offered by an entity other than the buyer or seller—can increase a label’s value by increasing its reliability and credibility. These services improve market efficiency by reducing uncertainty for producers and search and information costs for consumers. By increasing the value of information, third-party services can also boost the amount of information that producers provide to consumers through product labels. The four primary third-party labeling services are standard setting, verification, certification, and enforcement. A single entity could provide just one service or any combination of all four services.

  • Through standard setting, third-party authentication helps ensure consumers that a firm’s quality standards are meaningful for differentiation and are not simply empty marketing ploys. For example, “green,” “sustainable,” or “fair trade” could mean almost anything. Successful third-party standards establish a common terminology for goods possessing the same quality characteristics.
  • Verification services can take the form of either testing (such as testing that pathogen contamination or other safety problems are under control) or process verification (such as inspecting production facilities and bookkeeping records to verify that firms have adhered to safety and quality standards and followed specified production practices) or segregation and traceability monitoring to verify the existence of process attributes, such as organic, fair trade, dolphin-safe, and sustainable. These services help producers strengthen their labeling claims by providing an objective measure of product attributes.
  • Third-party certification provides evidence that testing and/or process verification has been completed and that the information supplied by firms or third-party verifiers is correct. Third-party certification provides an objective evaluation of the product’s quality attributes and helps firms establish credible market claims. Through accreditation, third-party certification can also establish the credentials of other third-party services, including other third-party certifiers. For example, USDA accredits third-party certifiers for the National Organic Program.
  • Third-party enforcement provides further assurances that quality claims are valid. Private third-party enforcement includes watchdog services and de-certification. Watchdog-type enforcement relies on negative publicity to discourage fraud. Firms with valuable reputations will be most susceptible to this type of enforcement. De-certification provides a clear indication that a product has failed to comply with quality standards. De-certification by government entities could carry the added penalty of prohibiting marketing of the product. Legal requisites concerning advertising and fraud provide the ultimate enforcement, even for voluntary claims.