The Economics of Product Safety in Consumer Markets

Often, the safety of products being sold and used by consumers is addressed legally and regulatorily. However, the basis of this product safety is based upon economic behaviour. Economic incentives significantly affect the decisions being made regarding the design, production, pricing and quality of products, which subsequently impacts the investments made by manufacturers with respect to product safety and the risk that is passed on to consumers.

The ramifications of product failures may extend far beyond the individual consumers; the ramifications of product failures also affect consumers' trust in manufacturers, competition among manufacturers and market efficiency. By viewing the issue of product safety from an economic perspective allows the identification of the reasons for the emergence of product safety standards and how market failures occur, as well as provides insight into the way that firms weigh the opportunity cost of reducing their costs versus the long-term economic viability of their companies.

This article presents an analysis of product safety as a result of advances in information, incentive structure and market structure.

Product Safety as a Market Efficiency Problem

Product safety failures indicate that the market is not functioning properly since it provides no incentive for the price and consumer demand to fully account for the risks associated with products. Theoretically, products that present a danger to consumers should see their demand decrease as well as the associated costs increase; however, due to the lack of correct information, the adjustment takes a considerable amount of time.

According to Statista, the FDA is responsible for recalling more than 90 million units of food per quarter in the United States; prepared foods make up the largest portion of these recalls, while baked goods, vegetables and beverages form the next largest categories. The majority of these recalls occur as a result of microbiological contamination which highlights the ongoing weaknesses in product quality control.

The economic effects of these product safety failures are quite apparent. Approximately 28% of American parents with children express concern for food recalls, which will lead to a decrease in consumer trust, change in demand and create welfare losses throughout the consumer markets.

Information Asymmetry and Consumer Risk

The imbalance of information provides a high degree of risk for consumers of goods in the market by making it difficult for consumers to make an informed decision regarding the quality or safety of the product being purchased; while sellers or manufacturers typically know much more about their products and/or manufacturing processes than consumers do. The issue of information asymmetry has been exacerbated in the marketplace, particularly on the internet, where there are often weak or delayed signals of product safety.

In a report prepared by the Organisation for Economic Co-operation and Development on e-commerce activities across 21 of its member and partner economies, it was shown that almost 90% of banned or recalled products that were examined in the report were still available for sale in the e-commerce marketplace. One-third of the examined products were not compliant with established safety standards.

The OECD also reported significant differences among various digital marketplaces regarding the time that it takes for them to remove illegal products from their respective platforms. The inconsistency in the removal of illegal products allows unsafe items to remain on those platforms and creates a greater degree of risk for consumers.

Litigation as an Economic Signal of Safety Failures

The emergence of a lawsuit is usually a delayed but powerful indication of the presence of underlying safety issues that have not been earlier recognized. Specifically, the emergence of a lawsuit indicates that there were not appropriate methods for adequately pricing, disclosing, or mitigating risks during earlier phases of the production and regulation process.

The illustration of this concept can be clearly seen in the case of the Bard PowerPort lawsuit. According to TorHoerman Law, the claims against Bard primarily focus on the design and manufacturing defect associated with the implantable port system. The medically implantable port systems are primarily utilised to deliver chemotherapy and long-term intravenous therapy. The claims of the lawsuit identify a broad spectrum of complications related to the implantable port system, including catheter fractures, blood clots, device migration and damage to veins and blood vessels.

These cases, therefore, reveal the lack of incentive to invest in safety based upon the perception that it was cheaper or more competitive to produce the device without investment in safety. The lawsuits serve as a way to correct this failure and impose additional costs (financial, reputational and operational) upon the firm, forcing the firm and the marketplace to reconsider how safety is valued and managed.

Cost Minimisation Versus Safety Investment

Companies are frequently confronted with the possible conflict between reducing expenses through cost-containment measures and investing in product safety. Cost-containment measures lead to improvement of immediate profit margins through direct cost reductions such as reductions of testing, material cost reduction, or quality control. On the other hand, cost-containment measures increase the likelihood of product failure in the future.

Currently available data from a recent industry survey support this claim. As an example, the results of a recent survey identified 73% of manufacturers had at least one product recall in the last five years, and the highest recall costs in the United States were as much as $99.9 million per recall.

These types of losses encompass logistical costs, lost sales, and damage to credibility. Although short-term cost-containment is economically viable; the longer-term damage caused by a lack of investment in safety is often much higher.

The Welfare Impact of Unsafe Consumer Goods

Unsafe consumer products have severe consequences to the population as a whole due to the harm done to people's health; as a result, these products will also result in economic costs as well as physical costs.

According to the US Public Interest Research Group, between 869 injuries due to unsafe products and the number of injuries due to unsafe products exceeds 7 years combined. Additionally, 15 people died from products that had been recalled and 10 people died as the result of the unsafe products that were sold by companies that did not take action to recall the products.

These injuries, deaths, and recalls also increase health care costs for individuals and businesses, lower individual earnings, and increase general uncertainty about the safety of products sold in the marketplace. The constant assaults on safety erode trust in the marketplace and, thus, result in lowering the entire economy.

Regulation, Liability, and Incentive Alignment

The alignment of incentives, and thus regulation and liability in consumer markets, is key to correcting market failures caused by manufacturers who do not assume the full cost of harm that their unsafe products cause. The liability laws serve to establish the financial responsibility of manufacturers for any harm caused by their products.

When manufacturers face both clear economic and legal consequences for unsafe products, they will have more incentive to invest in designing and manufacturing safer products and implementing quality control measures.

The regulatory body also assists with the flow of information among manufacturers and consumers by establishing minimum requirements for product safety and in mandating disclosure of safety information to consumers.

However, regulations that are poorly constructed may add to cost without achieving measurable results. Effective regulation provides a balance of enforcement and flexibility. The alignment of regulation and liability in an effective manner encourages innovation while reducing risk.

Over time, the effective alignment of regulation and liability helps to improve the operation of consumer markets, while also providing long-term protection for consumer welfare.

Frequently Asked Questions

Is competition in the marketplace enough to guarantee safety in products?

Competition in the marketplace does not provide a sufficient level of safety for products. Information gaps and cost pressures allow unsafe products to remain in circulation. Therefore, regulatory requirements and liability provisions typically provide a means for corrective action to align firm-level incentives to promote consumer welfare.

What impact does safety have on long-term brand value?

Safety impacts long-term brand value by creating trust and establishing reputations with consumers. Consistent performance with respect to safety helps to maintain stable pricing power and steady demand for products. Safety issues provide the basis for companies to recall products, experience litigation, and create lasting damage to their brand image, all of which contribute to poor company valuation over time.

Are product recalls used as a mechanism for enhancing economic efficiency?

Recalls may provide a mechanism for improving economic efficiency since they remove unsafe products from the market and provide for the correction of information failures. The short-term cost of these recalls may negatively affect the company's bottom line; however, they provide an opportunity for companies to rebuild consumer trust and prevent future harm from occurring. The recalls also encourage companies to appropriately allocate safety costs to their products, resulting in overall improvements in market performance.

Product Safety as an Economic Requirement

Product safety can be seen as a result of economic forces (e.g. market), the information available about product safety, and the design of institutions providing the information to the public. If the market does not accurately price the risk associated with a product, then unsafe products will remain in the market and consumers and society will bear the costs of these unsafe products.

The effectiveness of regulation, liability, and transparency allows for the proper alignment of incentives resulting in the restoration of the efficiency of the marketplace. Continued investment in safety leads to an increase in consumer trust, stability of demand, and improvements in overall market performance.