Who benefits from fair trade?

by Tyler Cowen 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?