What You Get is Not What You Paid For: New Evidence from a Lab Experiment on Negative Externalities and Information Asymmetries

In markets where ethical goods are available, consumers and producers can voluntarily address the negative externality market failure. However, in reality, these goods are often credence goods and the claims are not verifiable by consumers. We design an experiment to explore whether there can be voluntary internalization of negative externalities in markets controlling for different types of information asymmetry, namely credence claims with the potential for false advertisements, the possibility of certifying claims and finally mandatory truthful claims. We observe that there is a limited scope for ethical goods to be traded and negative externalities reduced in all informational setups. However, when false claims can be made, markets will appear very prosocial to the outside observer who will see widespread concerns for externalities and a price premium on allegedly ethical goods relative to conventional ones. In fact, conventional goods are just being falsely advertised as ethical. In addition, the price premium is seldom enough to cover the additional cost of producing a good that minimizes externalities. Even when credence claims are not allowed, the market will only partially internalize negative externalities, leaving thus room for some form of regulatory intervention.