A spate of toy recalls that dominated headlines in the second half of 2007 damaged the toy industry’s bottom line, according to a new research paper.

2007 saw a huge spike in the number of toy recalls announced by the Consumer Product Safety Commission (CPSC). Most of the toys had to be recalled because they were coated in lead paint.

In response, Congress passed the Consumer Product Safety Improvement Act of 2008, which tightened the allowable limit of lead paint in children’s products from 0.06 percent to 0.009 percent and required CPSC to set a general standard for lead that would limit the metal in the content of toys. It also boosted CPSC resources and allowed the agency to dole out stiffer penalties to ne’er-do-wells.

Unfortunately, potential damage had been done to any child exposed to the lead in those toys. And, it turns out, the damage was not limited to consumers. A new paper by two University of Maryland researchers, Seth Freedman and Melissa Kearney, and one University of Toronto researcher, Mara Lederman, finds that the recall notices hurt sales of those products: “[T]he types of toys that were involved in recalls in 2007 experienced above average losses in Christmas season sales.” (Thanks to the NY Times Freakonomics blog.)

That’s not a surprising finding. Here’s what’s interesting: the authors found that manufacturers saw a decline in sales, even if none of their products was subject to a recall: “Christmas sales of infant/preschool toys produced by manufacturers who did not experience any recalls were about 25 percent lower in 2007 as compared to earlier years, suggesting industry-wide spillovers.”

To further prove that the high number of recalls had a negative industry-wide impact, the authors also examined the stock market’s treatment of toy manufacturers and found that stock prices declined across the board: “We view the stock price patterns as prima facie evidence that toy firms in general experienced a drop in stock value relative to other sectors during the wave of 2007 toy recalls.”

Perhaps manufacturers will remember this information the next time they are lobbying to prevent new laws or regulations meant to make products safer. Not bloody likely.

Trade groups like the National Association of Manufacturers are pushing back against CPSC efforts to implement the Consumer Product Safety Improvement Act, including the lead-content standard and new rules that would require manufacturers to place tracking labels on children’s products in order to help consumers identify the source of a product in the event of a recall or report of harm.

While regulations can be a hassle for firms, they can also save a lot of pain and heartache later on. The public health crises (or financial crises, or environmental crises) that sometimes emerge when a market is under-regulated can bring dire consequences – not just for the public, but for industry too.

Image by Flickr user solsken, used under a Creative Commons license.