Silent Greenwashing: The Economic Case for Moving from Voluntary to Mandatory Environmental Disclosure

As consumers demand protections for the environment, corporations increasingly tout their sustainability efforts. Yet, economic indicators demonstrate that those efforts are mostly talk. Research and development on greener products and processes remains remarkably low, at about 4 percent of global R&D, and global emissions continue to increase. This raises an important question: Why do companies fail to self-regulate toward sustainability despite growing environmental concern among consumers?

Most economists would answer that only extrinsic incentives – carbon taxation, R&D subsidies – can effectively prompt a green transition. However, recent research challenges this view by showing that consumers’ environmental concerns can move markets in major ways. For example, Aghion et al. (AER: Insights 5:1-20, 2023) show empirically that an increase in consumers’ environmental concerns can spur green technological change as much as a large fuel-price increase can.

In a recent paper, I resolve this paradox by showing that markets are subject to a phenomenon akin to Gresham’s law: “Dirty” production drives out “clean” production because firms can mislead consumers about the environmental footprint of their products by taking advantage of a lack of environmental disclosure requirements.

Indeed, most statistics on products’ environmental footprints (carbon footprint, location of production, recyclability, impact on deforestation) are not seen by consumers, and firms do not have to disclose how they perform on these measures. Disclosure is voluntary, and consumers must rely on the information strategically disclosed by firms to form their perceptions about products’ environmental attributes.

I show in a voluntary disclosure model that this system fosters greenwashing: By remaining silent about their dirty practices, firms can exploit consumers’ bias toward wishful thinking to mislead consumers about the environmental footprint of the firms’ products. By reducing the difference consumers perceive between clean and dirty products, greenwashing depresses consumers’ willingness to pay for genuinely clean options, which leads to an unraveling of the green market. Marketing tricks become a cheap substitute for green R&D and genuine improvement of environmental quality. This explains why markets move so little in response to growing consumer environmental concerns.

Indeed, a striking feature of the evidence showing the ability of environmental concern to significantly move markets is that it involves product attributes for which there is no information asymmetry. Our theory does not apply for these specific attributes. For instance, the evidence of Aghion et al. relates to electric engines in the automobile industry. The engine type (electric vs combustion) is an attribute consumers observe and hence know at the time of purchase, explaining why environmental concern had such an impact on the development of electric engines.

Mandatory disclosure regulations could fix the environmental market failure by eliminating the information asymmetry about firms’ practices.

In my paper, I examine the mechanics of greenwashing and the resulting market failure and propose a path toward effective regulation for a genuine market transformation.

The Mechanics of Greenwashing under Voluntary Disclosure

The main factor enabling firms to greenwash consumers is wishful thinking – consumers’ bias toward believing the most agreeable scenario that they can rationalize. Wishful thinking is well-documented for environmental issues. It arises because consumers have no feedback from environmental attributesunlike attributes like flavor, the location of production or the carbon footprint does not affect the actual experience of consumption. Hence, overoptimistic outlooks are never challenged by personal experience. This forms the ideal ground for wishful thinking to flourish. In fact, evidence from experiments shows that the absence of feedback strongly predicts the occurrence of wishful thinking (e.g., Drobner, AER: Insights 4: 89-105, 2022).

In my paper, I show that, when combined with plausible frictions like the presence of naive consumers, wishful thinking enables dirty sellers to greenwash both naive and sophisticated consumers by withholding information about their practices.

To illustrate, consider the following example of yogurt disclosure that I collected in a French supermarket. In France, local milk is preferred by consumers for ecological reasons.  On the label of a yogurt container, the following information was disclosed: “Organic yogurt.” There is no mention of where the milk from which the yogurt is made came from. What perceptions will consumers form about the source of the milk? Consumers engaging in sophisticated reasoning will perceive that the milk is not French because, if it were, the seller would have said so; French milk is consumers’ favorite. Yet, many naive consumers may fail to draw this inference and entertain the possibility that the milk is French (as studies have documented; e.g., Jin et al., AEJ: Micro 13: 141-173, 2021).

In effect, naive consumers prevent sophisticated consumers from determining the source of the milksilence can be rationalized for both Spanish and New Zealand milk as an attempt to mislead naive consumers into thinking that the milk is French. Then, wishful thinking leads sophisticated consumers to perceive that Spain is the source of the milk, since it is the geographically closest source of milk they can rationalize. And it leads naive consumers to perceive that France is the source  since they fail to rule out France. Hence, sellers using non-EU milk can greenwash both naive and sophisticated consumers by withholding information.

As this example illustrates, silence can be a powerful greenwashing mechanism in the presence of optimism. The empirical greenwashing literature shows that silent greenwashing is effective and pervasive in modern markets (see, e.g., Baker et al., J Accounting Research, 2024).

Gresham’s Law — Greenwashing and the Unraveling of the Green Market

I show in recent economic models of the green transition that greenwashing leads to an unraveling of the green market and clean R&D. Greenwashing reduces the difference that consumers perceive between clean and dirty products, which reduces consumers’ willingness to pay for clean options and undercuts the demand for clean products. For instance, in our yogurt example, when comparing yogurts made from non-EU milk with those made from French milk, naive consumers, in effect, compare French with French, and sophisticated consumers compare Spanish with French. Naive consumers buy the cheaper non-EU yogurt, while sophisticated consumers may not buy the French product even if they would have if they had accurate perceptions and compared non-EU with French.

In an extreme case, if dirty firms manage to be perceived as clean, dirty production drives clean production out of business, regardless of consumers’ environmental concerns. This is the classic “lemons” problem described by George Akerlofa manifestation of Gresham’s law in the context of market competition: When markets cannot distinguish qualities, only the cheapest quality survives market competition.

Notice that the market unraveling can occur even when green and dirty products are differentiated (as illustrated with sophisticated buyers). While consumers may perceive products with eco-labels (e.g., certified zero emissions) as cleaner than those without it, consumers’ overoptimism about the unlabeled products reduces their willingness to pay for the labeled products, eroding the demand for clean products and dampening firms’ incentives to improve their environmental standards. This occurs even in an efficient system of voluntary certification where certification is without costs for firms.

The Role of Mandatory Environmental Disclosure

Mandatory disclosure can rectify this market failure by eliminating the information asymmetry, thereby exposing unsustainable practices to the pressure of the demand side.

A striking parallel to this dynamic is the notorious case of Nike’s child labor scandal in the 1990s. The revelation that Nike used child labor led to a significant public outcry and consumer boycott. Before the scandal, the lack of transparency allowed Nike to benefit from cheaper, unethical labor practices. However, once those practices were exposed, Nike faced considerable backlash, prompting the company to improve its labor policies significantly.

The journey of Nike from being embroiled in controversy to becoming a forerunner in corporate social responsibility initiatives demonstrates how mandatory disclosure could serve as a powerful catalyst for change.

More generally, empirical evidence supports our thesis. For instance, Kim et al. (J Marketing 86: 21-39, 2022) find experimentally that the shift from voluntary to mandatory disclosure of the use of genetically modified organisms (GMOs) almost doubles the market share of non-GMO products. Grewal et al. (Manag Science 65: 3061-3084, 2019) find that in EU exchanges, the mere passage — i.e., before actual implementation — of a regulation mandating disclosure of ESG ratings reduced the average returns of poor ESG performers’ stocks by 1.54 percent and increased those of strong ESG performers by 0.52 percent. (The regulation is the European Union (EU) Directive 2014/94/EU on disclosure of nonfinancial information.)

This impact has important implications. First, dirty processes become less profitable, creating incentives for producers to switch to cleaner technologies. The entry of producers in the clean market intensifies competition in that market, reducing prices and costs of clean products through price competition and clean innovation. The increased affordability of clean products creates a further negative demand shock for dirty products. This process being self-reinforcing, mandatory disclosure could foster the green transition in major ways.

Conclusion and Policy Implications

The article sheds light on the failure of companies to embrace sustainability under a system of voluntary disclosure. This both explains the persistence of the environmental market failure despite growing social-responsibility concerns and suggests that mandatory environmental disclosure could be a remedy.

This is important because, due to the well-documented unpopularity of the carbon tax, political constraints will prevent the implementation of a sufficient carbon tax to address the green transition (Blanchard et al., Ann Rev Econ 15: 689-722, 2023). It is thus essential to complement carbon taxation with other high-impact policies.

Mandatory disclosure could prompt major green technological change by restoring the pressure of the demand side on dirty production. As Napoleon Bonaparte said, “Shed light on a deceptive man, and he will behave as an honest man.”

This post comes to us from Julien Manili, a PhD student in economics at Northwestern University. It is based on his recent article “Beyond Pigou: Information Disclosure and the Green Transition of Markets,” available here.

Leave a Reply

Your email address will not be published. Required fields are marked *