Postprint version. Published in Journal of Environmental Economics and Management, Volume 52, Issue 3, November 1, 2006, pages 627-644. Copyright © 2006 Elsevier Inc. All rights reserved. The definitive version is available at http://dx.doi.org/10.1016/j.jeem.2006.05.002.
Consumers voluntarily pay significant price premiums to acquire unobservable environmental attributes in green markets. This paper considers the performance of eco-certification policy under circumstances where consumers cannot discern environmental attributes in goods, but are able to form rational expectations regarding the extent of illicit activities in the green market. The main results are: (i) fraud is less prevalent in green markets when entry barriers limit the number of firms; (ii) conventional environmental policies on polluting techniques increase the incidence of fraud, and can even preclude the use of non-polluting techniques which would otherwise emerge in green markets; (iii) voluntary eco-certification policies can decrease fraud, increase output, and raise profits per firm; and (iv) in cases where the socially optimal resource allocation can be supported, the optimal policy involves negative unit certification fees, positive fixed certification fees and is revenue-generating for the certifying agent.