Canadian Food Safety: A Wider

Canadian Food Safety: A Wider Look

Food Safety

Canadian Food Safety: A Wider Economic Look

Say there are only two grocery stores, your family is getting hungry and will eventually starve. In one store, everyone knows there is one product on the shelves that secretly is deadly poison and if all the food is purchased and consumed, whoever gets the poison will inevitably die a prolonged, agonizing death. The product can be on the front of the shelf or in back; could be an apple or an orange, a gallon of milk or a grain of rice; and it is definitely there somewhere. In the second store, there was a small but significant chance that anyone could possibly be killed at any time by any of the products. Where would you buy your family's dinner?

Then say I knew which product was the secret poison: How much would you pay for that knowledge? Then you could go to the first store and avoid the risk in both. What is the price of your or your family's life? You might pay say, two dollars, readily. On the other hand were the price two million dollars, the risk might seem more acceptable. Of course tomorrow is another day, a different secret poison product, and another two to two million. You all may also be killed on the way to the store, or if you simply do nothing. In fact the only certainty is that you will eventually starve to death without eating.

There are more than two grocery stores in Canada but otherwise this story is only a mild exaggeration. Ottowa's Globe and Mail has framed the evaluation and cost of risk reduction in terms of food safety, in a series of articles that shed light on principles underlying decisions as fundamental as what we can eat or not. As shares of imports to total food increases but Federal inspection resources remain unchanged, the relative number of actual products inspected falls, firms complain regulation cuts into bottom lines, and consumers respond they should get safe food for prices they already pay. Meanwhile, people occasionally die from imported food.

This paper will define the issue of food safety in more abstract economic terms, especially 'moral hazard' and 'adverse selection,' because these concepts underlie the decision processes the Globe and Mail frames in terms of food safety. These principles are described at length in a voluminous and expanding theoretical and applied literature, particularly regarding risk-based industries like finance and insurance, but which underly any market transaction where one party has more information than another. The questions of how much and which food should be inspected, who should oversee that and how much such inspection is worth, boil down to the simple questions of how much the consumer is willing to pay to reduce risk. This essay will outline these principles and argue the Globe and Mail story (series) both misrepresents certain aspects of this discussion, and entirely overlooks major costs and benefits that result from higher or lower levels of risk from imported food, regardless who inspects it.

Background and definition of concepts from the literature

Globe and Mail writer Steven Chase quotes food expert Rick Holley claiming "[f]ood safety in Canada, believe it or not, is an accident. It really is" (2010). In a literal sense, Holley's assertion refers to statistical sampling, whereby an attribute of a population, here food safety, is generalized from a partial sample for various reasons, usually the cost of testing all items of the population. With food, a different problem arises, in that testing destroys the food. The result would be nothing to eat, as writer Jessica Leeder (2010) points out in a companion article, quoting another expert from the Canadian Food Inspection Agency (CFIA). Therefore, if the sampling procedure is truly random, then safe food is literally "an accident" (Rick Holley, qtd. In Chase, 2010), because its safety is inferred from its proximity to food that actually was tested. Chase (2010) cites other expert opinion supporting this further on in the article.

But this is not the entire sense in which the quotation is employed. In a figurative sense, a government advisor disparaging food inspection for millions of potential consumers distorts the literal truth that the presence of a food on a grocer's shelf implies it has not been specifically inspected. Chase (2010) aggravates this sensationalism citing other past regulators but balances that by revealing incidence of food-borne illness is very low -- about four hundredths of a percent of meals eaten per year, at least for "acute gastroenteritis" (Chase, 2010), and that much of that incidence is caused by consumers after sale. Chase (2010) also reveals that reducing this incidence would take a vast increase in cost in order to achieve statistically measurable improvement. A critical reader must also look for bias in such quotations, because these inspectors have a stake in an expanding agency, i.e. their jobs. The result is a typical media balance of exaggeration between alarmism and the banal, except that the author makes one misstatement which is categorically inaccurate, and thus opens a window to discussion of the underlying theories of information asymmetry, adverse selection and moral hazard, via the question of who would bear the cost of inspections these experts claim are such an emergency.

Framing food safety as an "accident" (Chase, 2010) may be a distortion, but claiming that

"Ottawa's plan to require companies to provide information that traces primary food products back to their source will force new costs on companies, consumers and, inevitably, taxpayers" (Chase, 2010) is only partially true. Requiring increased information could cost distributors more, but they will pass this on to consumers, take less profits, or fold if either of those is impossible, true enough. Chase's error lies in using "inevitably" (2010). There are market-based options in which the taxpayer may not bear a cost increase at all, if the distributors or producers either comply voluntarily, or face inspection by independent third parties not funded by the Canadian taxpayer. The first option carries moral hazard because of information asymmetry. The second option would result in more of a 'user-fee' system wherein if the Canadian taxpayer did not want to pay for higher inspection cost for specific foods, she could choose an uninspected product or not eat high-risk foods, and thus would not bear the cost of regulation she did not incur. In such a case the Canadian might actually not see tax cost increases at all, and while this constructed example may carry other costs all consumers could bear, the direct cost of the inspection program would not "inevitably" devolve onto the taxpayer (Chase, 2010). Such a scheme may however induce tax costs Chase ignores, especially if price increases at the shelf exacerbate adverse selection in health care. This entails definition of these terms.

'Information asymmetry' is an academic way of saying that one person has more information than the other. In a market context this can move in two directions, usually where a seller knows that a good is worth less than the price or is known to malfunction at a certain rate, but consumers can also have superior information for example if a purchaser knew they were going to default on debt or had a potential health complication in the case of insurance. In the context of the Chase 2010 article, food producers and distributors hide the fact their products violate Canadian import standards, resulting in illness and recalls the CFIA would avoid through increased information about product origins. This sets up a market-based solution that encourages distributors and consumers to shun bad producers after violation, where distributors have a profit motive in making sure no violating product crosses the cash register. Harvard Economist Gregory Lewis (2007) points out information must be credible, which brings us to the problem with private-sector monitoring, the incentive to cheat, 'moral hazard.'

Nottingham University's Kevin Dowd explains that moral hazard arises when one agent has incentive to promote their own interest over the interest of others under their protection (2009). Moral hazard commonly arises when an actor does not bear the consequences of risk they decide to incur or not (gambling with others' money), assigns their own pay out of others' income, or gets paid the same regardless of productivity (Dowd, 2009). In our context producers have an incentive to pass on bad food to distributors if the retailer pays the consequences (Chase, 2010). In a fundamental sense Chase overlooks, if ingredient producers export substandard product in order to avoid taking a loss, the only way they directly bear the risk they generate is if they actually eat their own product. If a producer makes someone else sick without punishment, the financial incentive to keep cheating this way is called moral hazard. If the private sector's interest is contrary to or out of line with the public's, and the State represents the public interest against the private sector, then a dwindling share of State inspection may justify disparagement like Mr. Holley's (Chase, 2010) on grounds of dereliction of duty. If the State 'got paid' the same regardless of how many violations it prosecuted, that second dimension of moral hazard would overlap the primary incentive for producers to cheat.

Adverse selection is often considered a result, rather than a cause of moral hazard, where offering a risk-bearing product creates incentive for demand by the riskiest consumers. Obvious modern examples include offering expensive mortgages to high-risk home buyers, or selling life or health insurance at the same price regardless of consumer demographics. Not charging potentially sick or aged consumers more for health or life insurance sets up a stronger incentive for those customers to purchase than for the young and healthy, and therefore higher risk than the overall average. The resulting higher risk proportion is called 'adverse selection.' If credit costs extra for high-risk borrowers, low-risk borrowers will choose less-expensive product or won't need to borrow in the first place, with the result being a higher likelihood of default for the least able to pay with the highest cost compared to the total group average of all potential consumers. Lawrence Ausubel (1999) demonstrated adverse selection in credit markets before the recent wave of financial 'innovation,' and traces the history of underlying concepts back a century or more in insurance, with Ackerlof's seminal 1970 paper -- ironically here on the market for 'lemons' (used cars) -- demonstrating the result could be exactly the type of rationing that aggravated the modern banking crisis circa 2009. Demonstrating how adverse selection could result from increased regulation in private or public sectors reveals significant economic effects the Globe and Mail glosses over.

Conceptual model

The effects of this type of trade regulation can be modeled using traditional supply and demand curves, on the (positive, northeast) Cartesian plane with units of output on the X axis and price on the Y axis. Demand is generally downsloping for normal (i.e. non-luxury goods), where a normal good is one consumers purchase more of at lower prices or if incomes rise. The opposite is an 'inferior good,' one with a boomerang-shaped preference curve, which consumers buy less of when incomes rise. The supply picture can take numerous forms, but is usually upsloping, where higher prices encourage more production. Economies of scale can cause a series of stepwise plateaus for example; likewise if there is surplus production, demand can start out flat if higher consumption does not generate price increases. Long-run marginal cost (MC) is U-shaped, indicating high unit cost at extremely low and high output, with a minimum that maximizes profit for the firm when the cost of one additional unit equals sales price (revenue) for all units. Monopolists have an incentive to raise price at less output with higher profits but could produce and move more output at lower prices. In that case there is an artificial shortage of that good, at unnecessary cost to the whole society. Imposing external costs through regulation moves the supply curve to the left, reducing output at higher prices. Potential profits go unclaimed and society could be better off producing more. For public goods offered at one price regardless of demand, crowding sets in and shortages or rationing result such that demand also remains unfulfilled. These concepts all rely on standard assumptions like free mobility of labor and capital, unrestricted entry and rational consumers, which are patently questionable.

Analysis

Chase (2010) fails to follow the economic effects of food safety any farther than the tax bill or shelf price, perhaps because those effects ripple far beyond the space allotted for even the week-long series. Likewise an exhaustive demonstration of specific effects on the Canadian economy would exceed this available space, but even a simplified model of the costs and benefits of food safety can demonstrate ramifications beyond the Globe and Mail story.

Chase revises the taxpayer out of his estimate of who will bear cost toward the end of the 2010 article, explaining big producers and retailers who can bear increased regulatory cost will edge smaller firms out, even though comparable U.S. cattle tracking and accountability systems only constitute less than 1% of annual sales (this implies a hasty generalization all exporters will face the same cost proportions, incidentally). The result will be a concentration of supply where non-compliance will result in firm death after the initial government subsidy expires (Chase, 2010). Jessica Leeder elaborates on the incentive to cheat engendered by this threat of higher cost in the subsequent story (2010). Nowhere in the ongoing series does either writer consider the macroeconomic effects to the consumer from increased prices following regulation, and although Chase points out that the dangers of lax oversight include " cancer-causing fungicides... To dioxins in Belgian chocolates," causing "about 250 to 300 recalls of food each year" (2010), neither writer traces the costs of these recalls and health problems beyond 11 million or so cases of "acute gastroenteritis" (Chase, 2010). Including these costs could completely alter the conclusions drawn in the series, especially if cost change fed back across the macroeconomy through adverse selection.

Consider a simplified model where food constituted say 10% of the average consumer's disposable income (DI), where basic health care is provided through taxation and additional, boutique health services and insurance are available in private sector markets. Introduce the important constraint that healthier food is more expensive, but has overall benefits in the long run in lower incidence of obesity; diabetes; heart disease; cancer (Chase, 2010) and the like. This cost of health care includes lost productivity due to illness, which these authors ignore. Likewise imported food is cheaper than domestic substitutes or it would only be imported if there were no substitutes or production capacity. Add the cost of recalls and the result is a perfect storm of adverse selection the Globe and Mail completely overlooks. But what Chase and Leeder also ignore is that better food may in fact constitute a savings for the total economy if the increase in quality reduces health cost enough to offset the effects of increased shelf price. The ultimate outcome would likely depend on the proportion of health care costs to regulatory cost, and whether there were substitutes or not. A wider view demonstrates different possible results.

Say food cost increased to 15% of DI. Absent a pay raise, the consumer would have less to spend on private health care and overall social health would fall as higher overall food prices forced consumption of cheaper, more toxic food imports. Demand for public health care would increase, raising costs and thus taxation, providing even less disposable income for healthier food, pushing down on health quality, resulting in higher demand for health care; and so on ad nauseam, in theory. The most-able to pay would flee the public health care system (they could also afford the healthiest food), which would result in the worst cases falling on the taxpayer, i.e. adverse selection, with a new equilibrium at higher per-unit public health costs especially if healthier food consumption earned lower price for bolt-on insurance. Furthermore, the increased food cost would result in higher wage demands across all employments, resulting in general inflation and lower employment absent further price increases, at the same time tax costs were driven higher for the remaining income earners, which would reduce their spending power and restrict growth, aggravating general macroeconomic contraction unless offset by increasing demand for domestic substitutes (I ignore interest rate and money supply effects for space). Increased demand for domestic substitutes would increase domestic prices and mitigate flight from now higher-priced imports, at a new, higher equilibrium price for all foods if domestic supply was not able to increase enough to prevent domestic price increases. Many goods are imported simply because there are no domestic substitutes, Chase points out (2010), so no supply could offset this shift of the supply curve to the left.

At the same time a higher share of health cost to the total tax bill, especially where personal incomes were falling, would leave less funding for subsidizing private, public or third-party inspection. These inflationary demand forces and laxer oversight of an increasing share of less-healthy food imports would encourage moral hazard, or the taking of risks by producers, where domestic retailers bore the cost of unidentifiable, toxic imported inputs, because Canadian government was powerless to impose penalties in other sovereign countries. This would generate increased recall expense for the taxpayer and the food value chain, exacerbating contractionary forces at the same time intensifying adverse selection and moral hazard feedbacks.

The other side of this story is that if increasing inspection generated more savings in health care, including work days lost, than the aggregate food price increase, and stimulated higher demand for domestic substitutes, just the opposite could happen: Tax burdens could fall, lower-income consumers could afford healthier options, wait times in the health service would fall, leading to lower private medical expense; domestic producers would receive higher demand and thus prices and profit (i.e. more jobs), and moral hazard to impose risk on Canadian consumers for outside firms would be reduced. The Globe and Mail series makes much of WalMart's voluntary conversion to such healthier procurement and the effects for firms that can afford to invest in such goodwill branding. This higher cost of low prices still encourages consolidation, or the trend toward artificial monopoly, undermining benefits alleged to competition, but if the marginal, lowest-profit producers / suppliers have the highest incentive to cheat (moral hazard) and total monopoly can be prevented at the top end with anti-trust law, the result is a tradeoff where benefit comes with the cost of less choice, and the decision is between dangerous diversity or monopolistic safety. If economies of scale are significant, consolidation could deliver higher total output from the same amount of resources (efficiency).