Communicating clean technology: Green premium, competition, and ecolabels

In markets where differences in the environmental performance of competing firms arise due to differences in technology that cannot be altered in the short run and firms have private information about their own current technology, I show that market competition creates a strategic disincentive for adopting ecolabels (even if the cost of adoption is negligible) to directly and credibly communicate this private information to environmentally conscious consumers. Firms adopt ecolabels only if the green premium that buyers are willing to pay is large relative to the production cost advantage of dirty firms; ecolabels reduce market power, increase the market share of clean firms, and reduce expected environmental damage. I analyze firms' strategic (long-run) incentive to invest in the development of clean technology where the outcome of such investment is uncertain. The availability of an ecolabel to directly communicate private information about the final outcome of such an investment enhances the expected net surplus whereas it reduces the ex ante strategic incentive to invest which in turn lowers industry investment in cleaner technology, relative to the case with no ecolabels.