Welfare effects of product certification under latent adverse selection

•In markets with asymmetric information about quality, the presence of high quality is a positive externality that can sustain trade.•Perfect, costless certification of quality leads to a complete internalization of this externality and results in first-best outcomes.•However, even minimal costs or minor errors in a verification/certification process can result in a diminishing the positive externality resulting in a destruction of surplus well in excess of the direct costs of certification or direct costs of errors.•The result is tied to the importance of the interplay of welfare and information across certified and non-certified markets.•This interplay in welfare can also result in improved certification technologies that reduce or eliminate Type-II errors (false labeling) in diminishing welfare.•The findings pose practical implications for certification and labeling policies.