Who benefits from fair trade?

by on December 20, 2005 at 7:30 am in Economics | Permalink

…conservative commentator Philip Oppenheim…argued recently that in
Britain, it’s supermarkets that profit most from fair trade sales. They
charge a premium for fair trade bananas, for example, while a
"minuscule sliver ends up with the people the movement is designed to
help"…

Here is more.  In case you don’t know, fair trade sells a product at a premium price, under the promise that the workers are treated better and paid more.  But will that improve living standards?  Hmm…this sounds like a problem in tax incidence theory.  To make the best possible case for fair trade, I will assume the promise of good treatment is credible.

Let’s say the supermarket has some market power and would have liked to price discriminate on coffee sales.  Now you can buy either normal coffee or fair trade coffee, and the richer,
more conscientious people are willing to pay more for the latter.  Some people can be charged lower prices, while others pay higher prices.  Fair trade will likely increase coffee output, relative to a world with no fair trade.  Profits will go up.  But what happens to input prices?  Will wages of Rwandan coffee producers rise?

It depends on the alternative to market segregation.  It is possible that if only a single kind of coffee can be sold, the market would opt for the more expensive coffee, involving better treatment of all workers.  Even if you don’t expect this today, it might happen in a few years’ time.  If McDonald’s can improve the treatment of all the chickens it buys, maybe Starbucks or some other force will force the coffee sector to clean up its act.  So development optimists should be suspicious of fair trade.  It could diminish long-run general progress by giving the conscientious an outlet for their charity.  By splitting up the market, we are institutionalizing especially poor treatment for one class of workers.  Furthermore the high profits from price discrimination imply that
producers will be keen to continue such segregation rather than end it.

How about a genre called "Exploitation Coffee"?  You pay less, and they promise to treat the workers especially poorly.  That wording is a less effective marketing ploy, but that is what quality differentiation and indeed "fair trade" boils down to.

It is well known that price discrimination can either raise or lower the average level of prices, but it does increase price dispersion.  We can expect it to increase wage dispersion as well.  It is harder to predict whether price discrimination will raise or lower wages at the bottom level of the scale. 

By increasing output, fair trade can bid up wages for coffee producers.  But fair trade also diverts some drinkers from Exploitation Coffee.  If the switching effect is large, wages for producers of Exploitation Coffee can fall.  Just as we have created two classes of market prices, so have we created two classes of market wages.  If you believe that coffee producing firms have some degree of monopsony power, this is  sustainable and again will increase profits but possibly worsen human misery for the poorest.

These are all "existence theorems."  I would not be surprised to learn that current benefits from fair trade are positive.  But since I am a development optimist, I have reservations about the institution in the longer run.

Exam question: How much of this analysis also applies to free-range vs. factory-farmed chickens?  Hint: not all of it (why not?)  Comments are open…and might you know of empirical work on how fair trade influences wages?

UberIcarus December 20, 2005 at 7:56 am

Re: Free range vs. factory farmed.

Hrmm…my gut instinct tells me its different because a.) Free range chickens are a superior good, and b.) because the material conditions for a free-range vs. factory farm chicken are endemically and wholly different, rather than partially different.

In other words, the modern method of factory farming *requires* the “exploitation” of chickens, even as the firm makes more money. Low pay is not necissarily a requirement as a firm makes more money. Also, chickens have no wage market. So quality discrimination is not going to make the factory farmed chickens worse off, and is actually more likely to cause firms to defect to free-range.

UberIcarus December 20, 2005 at 8:12 am

Ooh…another insight. Specifically fair trade businesses might indeed have the monopoly effect of labor unions, when in competition with non-fair trade businesses. I.e., while workers will be paid better, there will be less workers overall, because the price increase results in a lower overall demand.

Chris Meisenzahl December 20, 2005 at 8:22 am

All good stuff Tyler! Did you ever see this?
http://www.mises.org/story/1548

For the last couple months Starbucks has also been selling fair-trade water. ;-)

Chris
http://amateureconblog.blogspot.com/

DK December 20, 2005 at 9:11 am

Follow-up question: how much of the analysis applies to chocolate?

Chocolate is different from coffee in that the issue isn’t wages, but slavery — a large portion of the international cocoa bean crop is reportedly grown by slaves, mostly children. “Fair trade” chocolate therefore is usually defined as chocolate grown by free workers. So, the difference in utility between special and regular chocolate is greater, and the moral issues are stronger. Is it as silly to buy slave-free chocolate as to buy fair trade coffee?

Disclaimer: I eat lots of chocolate, and yes, most of it is probably produced by slaves. The only slave-free chocolate I’ve found is the $10/bar stuff at Whole Foods, while most of the chocolate I eat right now is in the free Christmas party food category.

EclectEcon December 20, 2005 at 9:26 am

Another important difference between free-range chickens and factory chickens is that free-range chickens are much more likely to catch Avian flu from wild birds, whereas factory chickens are quarantined/isolated from before the eggs are hatched until they are “processed”.

Stefano December 20, 2005 at 10:21 am

My view is that fair trade can be modelled as a kind of boundling: coffee (or sugar or cocoa) plus charity.

There are many charities that sell “ethnic” wares at marked-up prices. Sincerely I don’t understand why economist are so skeptical towards the “fair trade” movement vs. other charities.

Moreover, in some case the “fair trade” shops buy directly from the farmers, thus eliminating middlemen, or use free labor given by volunteers; not all the extra price that is paid to the producers results in a mark up for the customer.

Josh Doherty December 20, 2005 at 10:40 am

Tyler:

I have qusi-insight/question post. If we look at the labor wage of FT coffee and apply the concept of MRP of labor for FT coffee, wages will rise IF the suppliers of FT product are concentrated. Otherwise, the FT is still a commodity product. This means that the main effect of increased prices must be viewed at each stage of production. As production moves from grower to retailer, the market is more concentrated and the ability to appropriate the price difference in FT increases. Therefore, the FT worker does not realize a real bump in MRP and therefore does not realize material gains in wage. However, the wholesalres and retailers are able to segment end-consumers and realize higher profits.

Finally, if more producers move to FT production, it further commoditizes the product and reduces the ability of producers to appropriate gains.

Is this accurate or faulty reasoning?

Thanks.

Josh D.

UberIcarus December 20, 2005 at 11:12 am

Josh D.: Wage factors under the “fair trade” umbrella are accorded by regional “living wage” standards, not necissarily MRP. I.e., it works like a minimum wage. So what would happen is that as MRP diminished fewer workers would be hired than under a prevailing wage.

Barkley Rosser December 20, 2005 at 2:30 pm

Tyler,

It should be kept in mind that some fair trade items,
notably a lot of coffee, is being sold through more
indirect channels such as churches. Presumably this
is not suffering from a supermarket markup in price.

Robert Speirs December 20, 2005 at 3:18 pm

Why is making farmers grow and pick coffee – or chickens – in a certain way because it’s “good for the workers” not the most patronizing and insulting interference imaginable? I also have to laugh at the idea of Bay Area liberals relying on large companies to protect workers! Feeling is SO much easier than thinking! At least on this blog there’s some thinking going on.

stuart December 20, 2005 at 4:42 pm

Eh? Improved the working conditions, for some workers. Don’t expect other workers left out in the cold to feel any gratitude. Chicken example is no good, factory farmed chicken is not justifiable.

stuart December 20, 2005 at 4:48 pm

Eh? Improved the working conditions, for some workers. Don’t expect other workers left out in the cold to feel any gratitude. Chicken example is no good, factory farmed chicken is not justifiable.

David Zetland December 21, 2005 at 5:22 am

Fair trade has intrigued me for awhile. I think a few of you have mentioned that middlemen count too, and the point about “non-fair” traders cutting out “useless middlemen” is a good one.

My favorite “fact” about fair trade is this one:
“In 2003, Starbucks bought 2.1 million pounds of fair trade coffee from worldwide sources; they also donated $3 million to these regions. The value of those purchases ($3 million) was less than 0.1 percent of total U.S. retail revenue for all stores ($3.5 billion). Advertising these (and other) achievements cost $50 million.”

This is from an essay I wrote that has been published in two non-profit magazines. Here is the pdf:
http://www.kysq.org/here/freefair_NC.pdf

– A slightly-ashamed self-plugger.

Johan Richter December 21, 2005 at 6:40 am

Chickens are not competing on a labour market. The “exploitation” chicken farmers will treat the chickens as cheaply as possible. Increased/falling demand for chickens will translate into more/fewer chickens being sold at a higher/lower price but will not affect the conditions for the chickens. This makes the very last point Tyler discusses, about possibly worsening the conditions at the explotation farmers, inappliable.

To put it another way, falling demand for poor workers will lower their price, ie their wage, and make them unhappy. Falling demand for chickens will lower their price, which the chickens could not care less about since the money goes to their former owner.

The relevant distinction is accordingly that the chickens are owned property while the coffee workers are free. If the workers were slaves it would be the chicken analysis that applied to them.

Stefano December 21, 2005 at 8:53 am

“So why don’t the “Unfair Trade” shops also eliminate those middlemen and become more profitable?”

Administrative costs, perhaps? Buying your coffee on the commodity market is probably more efficient if you’re a large company, than mantaining a large number of individual suppliers.

The “Fair Trade” shops I have experience with used very few suppliers (2-3 farmers coop, IIRC), so their admin costs were low anyways. Of course, having so few suppliers exposed them to the uncertainties of bad harvests, late shipment, etc. But their customers were probably more forgiving.

“I concur with your analysis that Fair Trade goods are bundling of goods and charity, but this begs the question of why this bundling is an optimal strategy.”

I think a lot of people give more happily when they get something in exchange, even if it is just a ribbon to pin to your lapel, or a flower. Many charities do that.

Or perhaps giving to charity seems more just when you are at the same time buying for yourself. This is why you find beggars near shopping centers, and not near tax officies.

Eric Rasmusen December 21, 2005 at 10:11 am

I wonder whether the post’s model can actually end up with any workers worse off, for the same reason as in one of the chicken farming posts above. With no Fair Trade coffee, workers will be paid the market wage– say, $2/day. For Fair Trade coffee, some will be paid $3/day. How is that going to reduce the wage of the workers still producing Regular coffee? True, the Caring consumers will no longer be buying Regular coffee, but they weren’t causing the wages there to be higher initially anyway– that was not a variable product characteristic then.
To be sure, if we now introduce Fairest Trade coffee, with workers paid $5/day, the Fair Trade wage may drop to $2.50 as the Most Caring consumers abandon it. But we haven’t gotten to that point yet.

Also: the model does not need price discrimination, I think. It still works if stores compete their prices down to cost.

Workers in the end will probably not be better off. If the Fair Trade practice is an above-market wage, as in my example above, workers will compete to get the jobs, on margins such as kickbacks, poorer working conditions, overqualificiations such as literacy, etc. If the practice is good working conditions, competition in other margins will similarly get rid of the rents– or, it may be that nobody values the good working conditions, so there are no rents to begin with.

Madan Manoharan December 21, 2005 at 12:51 pm

Tyler:

Your wrote: “If the switching effect [from Exploitation Coffee to Fair trade Coffee] is large, wages for producers of Exploitation Coffee can fall†¦..but possibly worsen human misery for the [Exploitation Coffee workers].†

Is this true in the long run?

Let us answer this question by taking your statement – “ By increasing output, fair trade can bid up wages for coffee producers. But fair trade also diverts some drinkers from Exploitation Coffee.† – as a starting point; lets continue this argument little further.

A decrease in demand for Exploitation Coffee will force the producers of this “brand† of coffee to either:
(a) Cut production: Cutting production might result in lay-offs, which will result in workers seeking other type of employment. Depending on the “other types† of employment available they might or might not be worse off;
(b) Keep production same but lower wages: Given downward stickiness of prices, some workers might quit (taking up other jobs, assuming that other equal paying jobs are available in the economy) thereby forcing the growers to increase the wages of the remaining workers; or
(c) Change their treatment of their workforce thereby re-branding themselves as “Fair trade Coffee†: The supply of “Fair trade Coffee† will increase causing retailers/distributors to lower prices to lure customers; this will result in the disappearance of the “Fair trade premium†.

Hence in the long run, the conditions of the “so called Exploitation Coffee workers† will not be markedly different from their current conditions.

-Madan.

Tom December 21, 2005 at 6:44 pm

Corruption is another unintended consequence of Fair Trade. I worked in coffee for an NGO in Nicaragua and saw this first-hand. Fair Trade certified farmers would buy coffee from non-Fair Trade certified farmers at the local market price of about $0.50 per lb and then resell it to international buyers as Fair Trade coffee for $1.25 per lb. The Fair Trade farmers pocketed the $0.75 difference and no one knew the difference because there’s no way to tell a “Fair” bean from an “Unfair” bean.

Another difficulty is which farmers get to become members of Fair Trade? More farmers want the guaranteed price floor than the market can accomodate, so someone has to regulate access to this scarce resource. In Nicaragua, Fair Trade has lots of left-wing Sandinista ties so farmers who fought with the Contras in the 80s civil war were blocked from joining.

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Sam Vilain March 15, 2006 at 9:30 pm

This point is entirely irrelevant if you find a vendor for your coffee that is providing it at the same price as the coffee without worker standards guarantees, or at the same price as their competitor that only stocks non-fairtrade coffee.

Using this simplistic argument, you can eliminate the need to ever consider where anything you buy comes from. Then you will become the perfect consumer – who is capable of consumption without conscience. It belongs in the bin along with terms like “Altruistic Dollar”

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