4 May 2016

How food labels increase information asymmetry

Isabel writes:*

We can no longer grab a bite or go grocery shopping without being bombarded with jargon such as ‘organic’, ‘Fairtrade’, ‘vegan friendly’ or ‘non-GMO’. Alongside the growth in demand for such products, food labels can increasingly be found in various shapes and sizes. The consumers’ correct understanding of what these labels mean is however very limited. Labels are often misleading, unclear or, as research has shown, wrongly located on products.

Why do we label food in the first place? Labels attempt to correct for information asymmetry between the consumer and producer. It supposedly gives the customer a clearer understanding of what is in their food, and assures food quality. This way the market can properly function, because consumers will purchase goods that best match their preferences [pdf]. Firms however may not have an incentive to provide consumers with full information. In these cases, labels inaccurately represent what is in the product and consequently consumers buy goods that are not what they intend to purchase.

An example highlighting such misperceptions is that consumers put “a higher value on the non-GMO label than the organic label". This is ironic, given that when something is labelled ‘organic’ this automatically entails it does not contain GMO ingredients. Vise versa, a non-GMO label does not necessarily mean the product is organic. That people prefer non-GMO labels therefore indicates that these labels are misunderstood. Another example of unclear labelling is the use of the word ‘natural’, which is yet to be defined by the food industry. 65% believes that ‘natural’ means no artificial ingredients, pesticides or GMOs [pdf]. However, it does not and thus consumers are left deceived by the food industry.

The above supports the opinion that food labels are increasing information asymmetry rather than reducing it. People trust labels without knowing what is really behind them. Because individual dietary choices can have a range of social welfare consequences, it is important that labels correct for these negative externalities. They should provide the consumer with full comprehensible information of the product. If this isn’t the case, they can not make a full informed decision resulting in food choices that increase externalities. Regulating food labels is a good start, but more importantly people need to start educating themselves on what labels really mean.

Bottom Line Misleading labelling of foods has increased information asymmetry between consumers and producers. People are unaware of what labels mean and trust them blindly. This results in people making less informed dietary choices that result in social welfare externalities. However, consumer’s have the right to know what is in their food and thus food labelling needs to improved.

* Please comment on these posts from my environmental economics students, to help them with unclear analysis, alternative perspectives, better data, etc.