With the recent establishment of the Single Market, international coordination of national product standards and regulations has gained new importance. In Discussion Paper No. 1384, Research Affiliate Stefan Lutz compares the effects of two alternative standard-setting arrangements (full harmonization of standards and country-of-origin principle) on national welfare, industry profits and consumer welfare. For this purpose, he uses a two-country model with imperfect competition. In the benchmark case with identical product costs, mutual recognition is the optimal policy choice. Full harmonization becomes a better alternative as differences in product costs get larger. Both countries will then prefer a uniform minimum standard permitting only the low-cost industry to operate profitably. The country losing its profits, however, will also benefit owing to the availability of a superior product. Under the condition that uniform standards must not induce exit of the low-quality industry, mutual recognition is always the preferable regulatory alternative.

The author draws two main conclusions: first, the country-of-origin principle should be applied in cases where technological differences between countries are small or the exit of industries is not a politically desirable option. Second, countries should consider accepting uniform standards, thus inducing their national industries to exit from the product markets where large technological disadvantage is faced.