Thursday, August 09, 2007

Is Fair Trade really fair?

Anyone that has ever soothed their social conscience through the purchase of Fair Trade coffee as an act of charitable consumption would do well to read this report from the Mercatus Center entitled Does Fair Trade Help the Poor? Evidence from Costa Rica and Guatemala.

First, some general facts about the world trade in coffee:

− Coffee is the world's most widely consumed pyschoactive drug and its second most traded commodity

− Of those, 18% drink speciality or gourmet coffee, which accounts for around half of the overall value of the US market

− The US purchased and imported around 22% of the 2005-6 global coffee harvest

− There are in effect two markets for coffee: exchange-traded commodity beans known as C market coffee which retails for approx. $5 per pound and privately-negotiated speciality coffees which can go for as much as $150 per pound

− So-called Fair Trade coffee falls into the speciality market, though is often not much better quality than the exchange-traded variety

− The markets for coffee are characterised by notoriously volatile cycles. A frost in Brazil can push the world price up and this incentivises newcomers to start cultivating. Around 5 years later the predictable surplus that results causes a crash in the price.

− Fair Trade certification is handled by a set of organisations acting under the umbrella of the Fairtrade Labelling Organisation (FLO). The basic idea, making affluent consumers pay a bit extra for a decrease in downside risk to the producer through the mechanism of a price floor used to have a less conscience-tickling name: the International Commodity Agreement (ICA) which was set up by JFK in 1962 as an interventionist economic tool for keeping the commies out of America's backyard. This system for stabilising the market lapsed at the end of the Cold War.

Its 21st century replacement, FLO, has a number of structural characteristics that limit its ability to deliver on its key promise to producers:

− The additional costs of certification can be very high and can include the costs of adapting operations to a cooperative structure and the alteration of accounting practices

− Fair Trade tends to fix prices at a level that is artificially high for the quality of the beans which creates a surplus on the market for which there is no buyer

− The number of gullible consumers identifying themselves to supermarkets as price insensitive through their purchases of Fair Trade products is certainly on the up, but still lags behind supply

− No coffee plantation which employs even ONE person as a full-time employee is eligible for Fair Trade status and individual farmers must sell to a certified cooperative

− "No matter how well run or benevolent a non-cooperative private organisation is, or how well it pays and treats its employees, it cannot obtain Fair Trade Certification," the report admits; which explains why the system has few fans in countries like Costa Rica where many private plantations are run on more socially-minded basis

− Coffee growers outside the Fair Trade system (in Guatemala they account for over 97% of production) can end up poorer as a result of the over-production encouraged by the small price rises that the incentive structure creates

− Consumers that purchase Fair Trade coffee are swapping the premium paid for extra taste for one that derives from extra ethical satisfaction. The system could never become universal without creating a strong incentive for producers to lower quality relative to the fixed price they are paid, so the majority of coffee on our supermarket shelves necessarily has to remain un-Fair for the system to work at all!

Fair Trade advocates tend to compare the price paid to producers for Fair Trade coffee with exchange-grade coffee, but this comparison is artificial (in Guatemala at least), as the crucial differential is really that with the market for gourmet beans. This is often quite negligible, and as Guatemalan farmers are aware that the price they ultimately get is a function of quality, to maximise their income they will tend to sell their lowest grade beans at the fixed Fair Trade price, and the rest on the open (speciality) market! So, in the words of the Mercatus report "Fair Trade inadvertently encourages mediocrity in production." It may also encourage the employment of scarce resources in high-cost/low-quality growing areas that could actually be better used for cultivating alternative crops.

Multinational corporations hedge risk by buying and selling contracts on the futures and forwards markets. Small cooperatives would need to hire at least one highly-educated employee before exposing themselves to the global financial markets...and the moment they do that they lose their Fair Trade status. And so it seems that to poor coffee farmers in Guatemala, the main benefit of the Fair Trade system is as a cheap, unsophisticated method of hedging against market downturns, which is of much less value to them during the upward curve of the cycle.

1 comment:

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