The Transaction Cost Origins of Food and Drug Regulation

This paper attempts to answer two questions. Why did state governments begin to regulate the food and drug industry in late 19 century America? And why did the federal government become the ultimate regulator of the food and drug industry in the early 20 century? I argue that state government regulation emerged as a response to high transaction costs (specifically information costs) in the market for food and drug products. The movement of food production out of the household and into the market, the rise of impersonal exchange, and the development of new food and drug products during this period increased consumer uncertainty about food and drug quality. Concerns about the adulteration and misrepresentation of food and drug items arose as a result of asymmetric information between consumers and producers. State regulation of food and dairy products was an institutional response to this asymmetric information problem. Regulation of the industry moved from the states to the federal government for transaction cost reasons as well. The proliferation of widely varying state regulations governing food and drug products combined with the rise of interstate commerce made the it costly to comply with and enforce state level regulations. Hence, large firms engaged in interstate commerce and state food and drug regulators pressured the federal government to assume principal responsibility for regulating the industry. The first hypothesis is tested using state-level data on food and dairy laws in the late 19 century. A model of Senate roll call voting on the 1906 Pure Food and Drug Act tests the second hypothesis. The results suggest that transaction costs were important factors driving the evolution of food and drug regulation during this period. _____________________________________________________________________________ * Ph.D. student, Department of Economics, Washington University, St. Louis, MO 63130. I would like to thank my advisor Sukkoo Kim for his invaluable guidance in the preparation of this paper. I have also benefited from discussions with Lee Benham, Johanna Francis, Mindy Marks, James Morley, and Douglass North. An earlier version of this paper was presented at the 2001 Canadian Economics Association Meetings in Montreal, Quebec. All errors are, of course, my own.