College of LAS « Illinois

Research

Governing ‘Green’

Making the marketplace more eco-friendly.

George Deltas

The market for “green” products is ever-expanding as more and more consumers factor environmental concerns into their purchases. Data released in March 2008 by Mintel, a Chicago market research firm, indicated that 36 percent of adults surveyed claim to “regularly” buy green products, while just 16 months earlier, only 12 percent said they “regularly” purchased green products. Also over that time period, according to Mintel, the number of people who had “never” purchased green products decreased from 20 percent to 10 percent.

Even though consumers increasingly may factor in environmental concerns when shopping for goods, that doesn’t mean the marketplace has responded with products that are as green as they could be, since consumers in general are not willing to pay the total cost of making that happen. That’s why government policymakers and other stakeholders continue to seek interventions that are consistent with a free marketplace and will result in safer products for the environment. But as University of Illinois economist George Deltas has found, not all policies are equally effective. Some designed with the intent to make products more eco-friendly have the opposite effect.

“We would like to find out what is the smart policy; what can deliver a lot of bang for the intervention,” he says. “We do not want policies that may be thought of as being good but are actually counterproductive because one has not thought two or three or four steps down the line to see what the long-term repercussions may be.”

Deltas and his coauthors, U of I agricultural economist Madhu Khanna and Donna Harrington of the University of Vermont, say one of the surprising results of his research showed that the establishment of minimum quality standards—for example, Corporate Average Fuel Economy standards that regulate auto fuel economy—may actually retard the progress of making products greener. A firm that must retool its product to meet a minimum standard gains an advantage over an existing greener competitor because it can now claim to be green, yet its product may still be cheaper than the product achieving higher standards.

The undesired result is that the firm that already manufactures a more eco-friendly product will have to cut prices to compete with the firm that was forced to improve its less eco-friendly product, a move that shrinks profits. Lower profits and market share may ultimately reduce the incentive for the greener firm to continue to produce a higher quality product and to keep improving it.

“You can actually do damage by implementing a minimum quality standard,” says Deltas, an associate professor of economics who has been at the U of I since 1995. “What happens is that you reduce the incentives of the firms that exceeded the standard to continue to make the same quality product.”

Taxation and cost-sharing subsidies, Deltas found, are interventions that may push firms who market green products in the same direction as firms that do not—to produce even more eco-friendly products.

The tax would be proportional to how much the product pollutes. Many large appliances, such as washing machines, are rated by how much energy they consume. The government could tax the product on a sliding scale—the more energy-efficient the product, the lower the penalty.

This type of policy would have the effect of making both types of firms—the large market leader which already has a green, and likely more expensive, product (Firm A), and the guy with the smaller market share and a dirtier product (Firm B)—clean up their acts, Deltas says. The incentives to improve their products are the same for both businesses—a lower tax on their product, which will be more appetizing to consumers.

“If you actually put in a sliding scale, you’re hitting both firms,” he says. “You’re actually providing a stronger incentive for Firm B to make the product greener. You’re also providing a stronger incentive for Firm A.”

Cost-sharing subsidies occur when the government or another stakeholder offers to pay a portion of the research and development costs to make a product greener. Although subsidies may achieve the government’s goal of more eco-friendly products, the firms may not like them, Deltas says, despite the fact that a subsidy seems at first to add to their bottom lines. This is because the firms still have to invest some of their own monies and, more significantly, if all the firms have the incentive to do the same thing, it will ultimately result in stronger competition, which may lower profits for all.

Deltas acknowledges that his research contains one major simplification—it did not factor in niche markets. There are some consumers who may be so sensitive to environmental issues that they do not consider expense in their purchases. So smaller firms may be flexible enough to market to those customers and turn a profit. Still, he hopes the results that he found can impact future policy decisions.

“Ultimately you want to make a difference,” says Deltas. “I think economists can be useful in making a difference by providing reasoned arguments about what policymakers should be cognizant of when they design policies. Clearly this work is meant to eventually help shape policy.”

By Laura Weisskopf Bleill
Spring 2009