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

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U.S. Food Regulations and Product
Differentiation Historical Perspective

• Bruce Gardner
• University of Maryland

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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

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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
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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

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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

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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)

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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

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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 sellers interest will be in
  cutting quality and free riding on the industry
  average (lemons problem).

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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.

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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

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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)

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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)

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Regulation as Tool of Monopoly

• With FDAs 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).

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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

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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

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Political Economy of Regulation

• Consumer protection advocates
• Manufacturers market protection
• Farmers attempts to limit buyers market power
• Farmers attempts to gain market power themselves

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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

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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.

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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.