U.S. Food Regulations and Product Differentiation: Historical Perspective

1. U.S. Food Regulations and Product Differentiation: Historical Perspective Bruce Gardner University of Maryland

2. 100 Year Old Discontents • Consumer concerns about threats to health, safety, or their pocketbooks • Farmers’ fears of exploitation by buyers, especially when selling products whose price depends on quality of product • Established firms’ claims of low-quality products spoiling the market for their similar but high quality products

3. These discontents are all related in a general sense to product differentiation – qualitative differences among varieties of a given product, or innovations in a product, or entirely new products related to old ones

4. Differentiation as Adulteration • Beck (1846) on adulturants: • lead for red color in cayenne pepper • Angell (1880s): • margarine, glucose • Meat Inspection Acts of 1891, 1906 • “embalmed beef” • Tea Act of 1897

5. Food and Drug Administration • Pure Food and Drugs Act of 1906 • Food Drugs, and Cosmetics Act of 1938. (FDA in USDA until 1940) • Truthful labeling: misbranding • Adulteration • Standards of Identity

6. Minimum Quality Standards • Marketing Order and Agreement Act of 1938 • Cover minimum size and/or grade • Today, Mandatory in Marketing Orders for 26 commodities ($4 billion in sales)

7. Argument Against Mandatory Quality Minimum • Absent the standard, buyers who are repelled by the low-quality products simply avoid them • With standard, low-quality products that could otherwise be marketed to the benefit of both buyers and sellers are precluded from sale • Probem: Argument assumes costless detection of quality at time of purchase

8. Argument for Mandatory Standards • low-quality goods create externality: experience with a low-quality product reduces the demand for the high-quality version • if consumers know only the average quality of apparently similar goods, they will buy according to their expectations of that average quality; and if sellers’ costs can be reduced by reducing quality, then each seller’s interest will be in cutting quality and free riding on the industry average (“lemons” problem).

9. Market Remedy for Branded Products • “It is in the interest of every businessman to have a reputation for honest dealings and a quality product.… Reputation, in an unregulated economy, is thus a major competitive tool.” • “Regulation undercuts the value of reputation by placing the reputable company on the same basis as the unknown, the newcomer, or the fly-by-nighter. It grants an automatic (though, in fact, unachievable) guarantee to the products of any company that complies with its arbitrarily set minimum standards.”

10. Objections to Relying on Branded Products • For some quality characteristics and/or some customers, the lying fly-by-nighters may flourish • Relying on branding opens new avenues for monopoly power • Relying on branding disadvantages small-scale sellers

11. Can Political Approaches Really Work? Case of Identity Standards • 1930s beginnings • 1950s peak • 1970s abandonment • “It should not have taken 12 years and a hearing record of over 100,000 pages for the FDA to decide what percentage of peanuts there ought to be in peanut butter” (Carter, 1979)

12. Critique of Regulation • Post-Progressive Era: Meat Inspection too much under industry influence after 1891 and even after 1906 • 21st Century: “…under HACCP, companies were gaining control of the inspection process and were letting dirtier meat get distributed to consumers” (Mattera, 2004)

13. Regulation as Tool of Monopoly • With FDA’s misbranding regs, established brand manufacturers used rule making to keep competitors from introducing differentiated products that might impinge on their market, by claiming that the new product was an adulterated or misbranded imitation of the established one (Miller and Skinner,1984).

14. What to Do? Regulation to Mandate and/or Provide Truthful Information • Nutritional Labeling and Education Act of 1990 • Labeling requirements • Extension and other educational programs • Organic Standards Act of 1990

15. Cost-Benefit Analysis • NLEA: FDA estimated social benefits of $4.2 billion compared to $1.5 billion costs over 20 years (based on estimae that 59 percent of consumers changed purchases and 6,500 reduced-fat products were introduced after NLEA went into effect. $4.2 billion is the estimated health benefit from the resulting improved diets (less fat and cholesterol). • HACCP • Organic Standards

16. Political Economy of Regulation • Consumer protection advocates • Manufacturers market protection • Farmers’ attempts to limit buyers’ market power • Farmers’ attempts to gain market power themselves

17. Attempts to Gain Farmers’ Market Power through Differentiation • Market approaches: • “Value-added” products • “Niche-market” products • Political approaches: • Hobble homogenizers (regulate contract farming, biotechnology) • Regulate corporate food differentiators • Small-business subsidies • Public education and extension

18. Summary: Difficulty of Assessing Market Situation • Multiple market failures make it difficult to pin down the relative strengths and consequences of departures from the first-best in the unregulated situation. It is therefore typically not possible to specify with sufficient precision the legislation that would achieve the (second best) optimum.

19. Difficulty of Political Solution • Given the lobbying forces at work, it is uncertain whether politically feasible policies will improve upon the market-generated situation. The difficulty is not only a matter of getting laws passed, but also getting laws passed that will not provide new tools for monopolistic distortion of markets.