Geographical indications and the competitive provision of quality in agricultural markets.

The market provision of quality is notoriously fraught with difficulties under asymmetric information: when producers cannot credibly signal the quality of their products, consumers' choices are predicated on the perceived average quality on the market, and this pooling equilibrium has undesirable welfare properties. Following Akerlof's (1970) seminal contribution, such market failures have been the object of considerable research. One possible solution has emphasized the role of firms' reputation as conveyed by their brands (Klein and Leffler 1981; Shapiro 1983). Brand names must themselves be informative, of course, and that in turns requires a credible trademark system. Trademarks thus serve as useful information tools for consumers by allowing them to more readily identify the goods of interest, thereby reducing the possibility of consumer confusion and economizing on their search costs (Landes and Posner 1987). Given that effect, trademarks also provide an incentive for firms to produce goods of consistent quality, as expected by consumers, lest they lose consumer loyalty and suffer a loss on their investments in trademark development. (1)

Brands and trademarks are best understood in an imperfectly competitive setting. Their role in agriculture and food production, largely characterized by competitive market conditions, remains an open question. Individual firms are typically too small to credibly signal quality to consumers directly, and this is one of the justifications for specific types of government intervention such as the development of food standards and grades, a specific mandate of U.S. federal agencies (Gardner 2003; Lapan and Moschini 2007). (2) Alternatively, producers could bundle together to achieve the critical mass required for brand name and trademark development. A particularly interesting instance of such cooperation in the provision of quality is represented by the use of geographical indications (GIs). This use of geographically based labels to brand products has been in use for a long time, especially in Europe, but interest in GIs increased considerably after they were recognized as a distinct form of intellectual property (IP) rights in the TRIPS agreement of the World Trade Organization (WTO) (Josling 2006). In the context of GIs, quality attributes of interest to consumers are presumed linked to the specific geographic origin of the good and/or particular production methods used in that region (the notion of "terroir"), and such attributes cannot be determined through inspection by the consumer prior to purchasing the good. The fundamental role of GIs in this setting, therefore, is that of providing a credible certification mechanism that solves a real-world information problem.

Some recent contributions have addressed directly some of the specific economic issues related to GIs. Zago and Pick (2004) question the desirability of GIs by showing that, with an exogenously determined supply of quality, the welfare implications of a fully credible certification system based on GIs are ambiguous. In Anania and Nistico (2004), low-quality producers can choose to sell their product on the high-quality market (i.e., to cheat). Given an imperfect enforcement mechanism, a GI regulation might be desirable for both low- and high-quality producers. A few studies have suggested that GIs can be interpreted as "club goods" (nonrival, congestible, and excludable), as discussed in Rangnekar (2004), chapter 4, and this interpretation is adopted by Langinier and Babcock (2006). The government provides GI certification rights to high-quality producers, who are free to decide the size of the club (i.e., who among the high-quality producers has access to it). Lence et al. (2007) focus on the problem of developing new GIs. The key to developing such products is a fixed cost. Certification is implicitly free in their setting, and thus costless imitation is possible, so that some degree of supply control may be necessary to encourage geographic product differentiation.

In this article, we emphasize that the natural institutional setting for GIs is that of competitive markets. Contrary to standard trademarks, which are owned and used by a single firm, GIs are essentially public goods and are used by many firms simultaneously. Moreover, the use of a GI cannot be denied to any producer in the specified geographical area, an issue that has been overlooked by previous work. Indeed, in the European Union (EU) where GIs are widely used, there are typically no limitations on which or how many firms can use a given GI (provided that all product specifications, including the geographical origin, are met). Similarly, in the United States where GIs are mainly protected as certification marks, any firm that meets the certifying standards is entitled to use the corresponding certification mark. Accordingly, the purpose of this article is to investigate the impacts of a credible GI certification system in a competitive market setting characterized by the possibility of free entry, and we derive and discuss the welfare effects to be expected in such a context.

Our analysis complements and adds to existing studies in this area in some novel ways. For instance, most studies discussed in the foregoing (Anania and Nistico 2004; Zago and Pick 2004; Langinier and Babcock 2006) assume that producers are ex ante and exogenously identified as either of the low- or high-quality type. In particular, high-quality producers supply the high-quality product regardless of whether or not they are certified and/or receive a price premium in the market. We relax this constraining assumption and allow the (costly) provision of quality to be endogenously determined. Furthermore, in our model the production of high- and low-quality goods can coexist in equilibrium in the same area, which also captures a feature of the real world where not all producers in a given GI region take advantage of their right to supply the GI products. Finally, and perhaps most importantly, we analyze explicitly the implications of competitive entry within a coherent model of quality certification through GIs, an issue that, to date, has not been addressed.

In what follows we first review the institutional setting for GIs, with emphasis on policies implemented in the EU, a leader in the development and use of GIs. This allows us to substantiate our premise that both the letter of existing regulations and the observed practice in the predominance of cases suggest that the relevant market setting is a competitive one. In particular, entry of new firms that wish to produce GI-certified high-quality goods is possible. Based on that, we then specify a model to study how the competitive structure of agricultural production affects the supply of quality in the presence of a mechanism that mimics the nature of a GI. The model, although by necessity very stylized, captures the essential elements of the problem at hand. In particular, the demand side of the model is rooted in the economics of product differentiation, which provides an attractive formulation on how consumer preferences value quality. On the supply side, our model allows for different production costs for high-and low-quality goods and permits the supply of the high-quality (GI-certified) good to be endogenous.

The characterization of equilibrium centers on the competitive conditions with free entry/exit. In the benchmark case, in which all input costs are parametrically given, the need for costly certification that involves a fixed cost induces increasing returns to scale at the industry level. Consequently, the competitive equilibrium is not Pareto efficient; specifically, it underprovides the high-quality good. This equilibrium, however, does entail welfare gains relative to the absence of GI certification, and thus, it does ameliorate the information market failure that motivates interest in GIs. In this setting, some simple policies that subsidize the GI certification of quality would restore Pareto efficiency to the competitive equilibrium. Perhaps not surprisingly, given the long-run nature of the competitive equilibrium that we consider, the welfare gains due to GIs mostly take the form of increased consumer surplus. The availability of GIs benefits producers only when the production of the high-quality good draws on scarce factors owned by producers.

The Institutional Framework

Whereas recent motives of interest in GIs stem from their recognition as distinct IP rights in TRIPS and the ongoing efforts to strengthen such rights, protection of GIs has a long history in some European countries and elsewhere. GIs are protected under two similar yet distinct legal notions: appellations of origin and marks. The primary difference is that an appellation of origin requires the existence of a special tie between the quality of the product and its geographical origin, whereas in the case of a mark such a relation is not necessary. (3)