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Fair for Whom?

The Fair Trade coffee movement ought to be renamed the “Failed” Trade coffee movement.

While coffee prices seem to have”stabilized”, the Fair Trade movement seems to have been launched in order to raise the incomes of coffee planters. Several arguments are made for why coffee planters make such low wages. The most prominent is that coffee buyers exercise oligopsonistic power in the market. In other words, these few buyers can exercise power over potential suppliers and “force” prices below their “true” prices. I’ll leave that discussion for another day. The second argument offered is that between the time coffee leaves the field and makes its way into your cup, up to 150 different intermediary dealers will get in the way, substantially raising transactions costs and reducing the amount coffee farmers are able to receive.

The program simply works by having new “middlemen” step in to replace the many other intermediaries, and guarantee a minimum price for coffee sold to the farmers interested in entering the program. The Fair Trade movement then tries to sell the coffees at premium prices.

Well, one “problem” in coffee markets was that there were huge supply increases until very recently, pushing down prices. Quick question for an intro economics student – what should you expect to happen to the equilibrium in the coffee market when we establish a price floor? Uh … since we increase the price farmers might expect to get from growing coffee, we will induce even MORE farmers to want to plant coffee. Like throwing gasoline on a fire. Of course, those that get higher prices (I am not convinced it ends up in their pockets) might be better off, but aggregate well being must be lower, and the long-term “problem” is actually more serious (also for our intro students – ask yourself what other unintended consequences might arise from such a program). So the program, at its core, simply gets the economics wrong. A better program would have been to pay people NOT to become coffee growers – isn’t the goal to help them anyway?

And then it tries to sell you on the program by preaching just the OPPOSITE of what good economics tells us. Why do middlemen exist? To extract bribes from us? To parasitically suck out a little bit of the profits that sellers really deserve? Maybe that is your world view, but middlemen actually play an extraordinarily important coordinating role in any economy. In other words, they make it easier for buyers and sellers to find one another – they REDUCE transactions costs. The folks at Fair Trade are arguing that the existence of middlemen in coffee markets INCREASES transactions costs.

Of course, it could be true (and this is how people get rich) that you could find a way to do it more efficiently, and hence reduce transactions costs – and you are free to test this. But if the presence of Fair Trade actually eliminates middlemen and lowers transactions costs, then the way that they would compete in a market is by lowering the price of Fair Trade coffee products, not by raising them! That is how you compete for customers in a marketplace – and what Walmart does successfully, as well as any other successful enterprise. However, this is NOT what Fair Trade is doing. They actually try to persuade customers to buy Fair Trade certified coffee at a premium over what non-Fair Trade coffee brings in. Something is not right in Java world.

At least it is voluntary, even if customers are being misled.

3 Responses to “Fair for Whom?”

  1. Michael says:

    The first time that I heard about Fair Trade was in a sustainable economics class I had. Would you believe that the teacher (an economist, mind you) raised no challanging questions about Fair Trade? A ton had flooded my mind, chief among them was the price floor. Then with excess coffee potentially being grown, how is that sustainable for the environment?

  2. MZ says:

    I too had similar questions when introduced to Fair Trade, but based on my own research (primary (Nicaragua) and secondary), I suggest your analysis is based on flawed assumptions:

    1. Coffee is homogenous
    Looking at global supply and demand of coffee gives a distorted view of things. Fair Trade coffee generally competes within the specialty coffee market, which is approximately 25-30% of the total market.

    The specialty market has not (yet) suffered from the same supply issues that have plagued the commodity market, and was even dynamic and bullish during the “coffee crisis” between 1999-2003.

    2. Price floor = subsidy
    People often mistake the price floor for a subsidy, which triggers the standard argument that subsidies lead to excessive production.

    Things to consider:

    FT certified producer organizations do not necessarily sell all of their coffee through the Fair Trade system, rather they sell as much as they can to it (limited by demand and other opportunities), while selling the rest through other markets (organic, specialty, commodity, domestic, etc). Unless able to sell 100% to the FT market, equating the FT price floor to a universal price subsidy is indefensible.

    Even if we’re talking 100%, the prices paid within the specialty market can (and often are) higher than the price floor. More important than the floor here is making sure those high prices paid make it to the producer. This is where intermediaries and power come into play, and where disconnect between market value and farm-gate prices occur. Fair Trade directly addresses this.

    In terms of actual production, only small scale farmers can access the FT coffee market (by way of democratic producer organization), which operates under a different production logic than a larger coffee farm.

    With the latter, it’s reasonably fair to assume the factory-logic you have above (higher marginal revenue could be expected to lead to increased production until economic profit equals zero).

    But small-scale coffee farms have more objectives than coffee production, which makes the assumption of higher prices=higher production less defensible. Such farmers use their farms to produce food, and they have an interest in a diversity of income streams to manage risk.

    On a survey (of mine) of about 25 farms, nearly every farmer reported capping the percentage of coffee farm to total farm based on considerations outside of coffee prices. I found farmers who capped despite rising prices, and at least one farmer who had been increasing production during a period of bottomed out prices (complicated explanation).

    Small scale farms are also limited in their ability to ramp up production due to land limitations (proximity is more important to a small-scale farmer than a large one), the competing interests described above, and, in some cases, access to farm inputs (fertilizers and labor).

    According to both the ICO and World Bank, small-scale producers represent approximately 90% of farmers, and 50% of production.

    (To Michael: Have a look at the Smithsonian Bird Institute’s report on birds and coffee farms from 1998 (I believe) or a journal search of “traditional coffee methods”, “coffee forests”, etc. to get an understanding of the environmental significance of supporting small scale coffee farming).

    3. Middlemen reduce transaction costs

    Of course, this depends on what they do. The middlemen usually decried by Fair Traders are those engaged in cartel-like behaviour and who take advantage of asymmetrical power and information (usually within the producing countries).

    4. Fair Trade means retail regulation

    It was strange to see what was otherwise a standard laissez-fair argument capped off by what almost appeared like a call for retail regulation (though you may have been giving advice to the people charging a premium, I couldn’t tell). Just to get it out of the way, there’s nothing in the Fair Trade standards that regulates the prices consumers pay for Fair Trade products.

    As for the price point, Fair Trade coffee prices are generally about the same as their non-FT equivalents. This largely results from its relationship to the specialty market described above.

    Some companies do try to to charge more because they think the market will bear it, and others charge more because their costs actually are higher (not because of the price floor though). Either way, this is where competition comes into the fore, and I’m not too worried about it.

    BTW, you do know that Wall-mart is selling Fair Trade products now, right? Coffee and wine, among other things…. Not everyone’s happy about it, but maybe it’ll give you some peace.

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