Adam Smith Institute and FairTrade

The Adam Smith Institute is known for its robust support for free markets. Their blog is always interesting and often well-informed; and they enjoy taking unconventional positions on topical policy issues. But every so often, the position they take is not well thought through, and not consistent with their general philosophy. It feels as if they are just being contrary for the sake of it.

Today’s blog by Alex Singleton on Fair Trade is an example of this. He criticises Fair Trade, because he says it depresses world coffee prices.

Of the 2 pounds that you pay for a normal cappucino in London, the coffee producer may earn about 5p. Some consumers – me among them – prefer to buy products that pay a fair price to the producers who supply them; and are willing to pay extra for this. This is a legitimate preference. The Fairtrade system enables us to do this, by buying products that have a symbol that tells us that the producers have received more than the market price for the commodities they have produced.

Fair trade is a good example of the market supplying goods and services in response to demand. Consumers are not required to buy fair trade products; but if this is what we prefer, the fair trade certification system enables us to do so. The Adam Smith Institute should welcome the expansion of consumer choice that this provides us.

Fair traded coffee alone results in more than $30 million a year additional income for coffee producers, which in turn supports them, their families and their communities. I would have expected the Adam Smith Institute to support, not criticize, a mechanism that enables the poor to trade their way out of poverty.

With apologies for the length of the post, I think it is worth rebutting each of Mr Singleton’s points in turn. In most cases, it is not that the point is factually inaccurate: just that Mr Singleton has drawn the wrong conclusion from it.

We do not have free trade in farming. Rich countries engage in unfree trade. Developing country farmers are held back by unfree trade, not free trade.

Agreed. The hypocrisy of rich country trading arrangements is one reason why some consumers in rich countries want to choose products which provide some redress, if only a little. It is entirely consistent to want to see the Common Agricultural Policy reformed or abolished, and to want to buy fair traded products.

Fairtrade appeals to a minority of buyers. Only 1% of the world’s coffee is Fairtrade. Most people buy according to price and quality.

It is true that fair traded products have a small market share, though this is changing fast. The market share for fair traded coffee is doubling every two years, and it is the fastest growing segment among speciality coffees. But in any case, why should the relatively small size of the market (so far) be a reason for consumers not to have this choice?

Fairtrade helps relieve middle-class guilt. By so doing, it takes the emphasis away from the real problem: Europe’s agricultural policies.

Fair trade and reform of the Common Agricultural Policy are basically unconnected. But if anything, the opposite is true. By buying Fairtrade, consumers are demonstrating that they care whether farmers in developing countries get a decent price for their product, and so adding to the pressure to reform Europe’s agricultural policies.

Mechanization means that only a small proportion of the world’s coffee producers are actually needed. In Brazil five people and a machine produce the same amount of coffee as 500 people in Guatemala. We should help people adapt, not encourage them to stay in outdated jobs.

Buying Fairtrade gives developing country producers additional income which enables them to invest, in themselves and their children, and so provides opportunities for them to adapt.

Coffee prices are low because there is too much being produced, not because of the actions of multinational companies. Companies like Starbucks have helped increase consumption of coffee, which is good for producers.

Absolutely. Fairtrade seeks to increase, not reduce coffee consumption. But it allows consumers to choose to buy and drink coffee that pays a fair return to coffee producers.

25% of the world’s Fairtrade coffee comes from Mexico, a relatively affluent country where the average income is $9000 (compared with $700 for Ethiopia). Mexico enjoys free trade agreements with the USA and Europe, and most of its jobs are industrial and service sector jobs. By helping Mexicans stay in the market, the Fairtrade scheme keeps the world price of coffee down and takes business away from poor coffee producers.

It is true that Mexico is, on average, richer than Ethiopia, though it is also very unequal, and there are still many poor people in Mexico. More than a quarter of Mexicans live on less than $2 per day. More importantly, it is economic nonsense to suggest that for consumers to be willing to pay more for coffee, in order to ensure a proper return for the producers, can somehow depress the world price of coffee.

Markets convey information through prices. The low price of coffee tells producers to produce more cheaply or exit the market. At the end of the day, too much coffee is being produced.

Markets do indeed convey information through prices. One piece of information that prices can convey is that some, though not all, consumers have a preference for products which have not been supplied at the expense of very low and uncertain returns to the producers. The Fairtrade scheme enables the market to translate this consumer preference into purchasing decisions. Without it, there would be no way for consumers to express this preference.

 

If too much coffee is being produced, it is not because of fair trade coffee. (If the Adam Smith Institute wants to make a well-informed point about this, it could look more closely at World Bank subsidies to coffee production in Viet Nam, which may well have depressed world coffee prices; but that is a quite separate debate).

19 thoughts on “Adam Smith Institute and FairTrade”

  1. Excellent post, Owen. Alex ignores the fact that the market power of various firms in the coffee production chain allows them to depress the price paid to farmers while keeping the price charged to consumers high. The result is a massive transfer of wealth from farmers in poor countries and global consumers to these enormous corporations. Of course, the Adam Smith Institute will never bring itself to criticise even the most oligopolistic private firm, so I can only conclude that it doesn’t really believe in free trade after all.

    Jim

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  3. Owen, I rather like your analysis….especially the implication that as Fair Trade is voluntary, those paying the higher prices are increasing their utility by doing so. Not something I’d thought through before.
    Disagree on a few other parts of it (and Jim’s insistence that it’s all about eeevil corporations) but that one point definitely interesting.

  4. Except that many activist students at colleges are delibarately pushing that the college provide fair trade coffee, which is not at all about consumer choice. If it was simply a matter of “I want to buy this certified coffee as opposed to this uncertified coffee” there is incredibly unlikely the issue would have gained such prominence.

    This statement is just plain wrong

    “More importantly, it is economic nonsense to suggest that for consumers to be willing to pay more for coffee, in order to ensure a proper return for the producers, can somehow depress the world price of coffee.”

    If a buyer is removed from the pool of buyers of uncertified coffee(by the action of buying certified coffee), ceteris paribus, there is less demand for uncertified coffee. Hence the price for uncertified coffee (i.e. the world price of coffee) goes down.

    That is economics at its most basic, so it was incredibly rude and ill-informed of you to criticize the Adam Smith Institute for progagating “economic nonsense.” It’s actually rather ironic too, as such simple economic truth seems to escape your own conceptual grasp.

  5. Thank you for reading this and taking the time to reply.

    On your point about the coffee price: given that one of the Adam Smith Institute’s other points is that the demand for Fair Trade coffee is very small, it is hard to see how fair trade would have any effect at all on the price of uncertified coffee. However, you are right: the price of uncertified coffee could, in principle, go down.

    But the average price for all coffee – including certified and uncertified coffee – cannot possibly go down – it must go up, or stay the same. So I stand by my statement that it is economic nonsense to claim that fair trade depresses the world price of coffee.

    On your first point, about activist students giving the issue prominence: would you – or would the Adam Smith Institute – condemn the work of the advertising industry because it gives “prominence” to products available for consumers and seeks to persuade them to buy one rather than another? If not, why are student activists who seek to persuade people to choose fair trade any different? In the end, it is still the consumers’ choice.

  6. I don’t want to turn this thread into a debate of my own, but I just thought I’d point out that contrary to Tim’s characteristic over-simplification, I don’t believe that oligopolistic corporations are the *only* cause of the problem. But they are clearly a major contributor – to deny that is to deny the economic reality.

  7. If there is in fact an oligopoly of coffee buyers (oligopsony in the infelicitous phrase) then the correct response is to break it up. I know Jim thinks of me as a defender of Big Business but I’m not, sorry, monopolies and oligoplies should be broken where this is possible. However, I’m not quite sure that this is true in the coffee market. A few large companies dominating a market is not prima facie evidence of such, it is also a defining characteristic of a mature market with economies of scale. The question is whether those companies have pricing power. Given that coffee is traded on open commodity markets, it is difficult to see that the buyers do indeed have pricing power over the wholesale price of raw coffee beans. I’m sure they do have pricing power in the consumer market, that is what brands are all about after all, but would need more proof before concluding that they do in the wholesale market.
    Owen, what do I disagree with in your analysis? For one, Fairtrade seeks to increase consumption. I simply cannot see that raising the price of something raises its demand, unless you are claiming that coffee is a Giffen Good?

  8. Tim

    I think we can agree that coffee is not a Giffen good.

    If I understood it correctly, Alex Singleton’s argument was that Fair Trade increases the supply of coffee, and so reduces the world price.

    And if I understand your point correctly, you are saying the exact opposite: Fair Trade increases the price of coffee, and so reduces the quantity sold.

    Clearly, these critiques cannot both be true. Actually, i think neither is right.

    In simple aggregate terms, fair trade shifts the demand curve outwards, increasing both the quantity sold and and the average price (with upward sloping supply curves). A more sophisticated version would be that fair trade creates product and price differentiation, and so allows coffee producers to capture a greater share of consumer surplus, increasing the average price of coffee. (The reason that both prices and quantities increase is that this is a shift in the demand curve, not a movement along it.)

    The way to think of this is that Fair Trade is a brand. When Coca Cola invests in increasing its brand value, eg through advertising, it does so because this increases both the volume of sales, and the price it can charge. I don’t think anyone at Coke complains that increasing the price they can charge for Coke makes them worse off. And though Coke’s competitors may lose market share, it is unlikely that the price of other colas falls when the price of Coke goes up (more likely, the opposite is true).

    So uncertified producers may lose, as a result of a small lost of market share and possibly slightly lower prices, though at current fair trade volumes these effects will be small. But for coffee producers overall, average coffee prices will be higher, volumes higher, and coffee producers better off.

    Owen

  9. Coffee may not be a Giffen good, but could Fair Trade coffee could be seen in terms of the Veblen effect, where a rise in price of a good can lead to in increase in demand for a product for ostentatious reasons?

  10. OK, got the branding bit, agree with you. Precisely that can mean that both Alex and my argument are valid…in what I think Alex was saying rather than what you think he was saying.
    Alex’s is that by paying a higher price to coffee growers we are increasing the number of those willing to supply coffee. As we are only paying the higher price to some growers, the price received by other growers must fall, for we have increased supply but not demand. We have also increased the price at the point of consumption, thus reducing demand (in the abscence of the Veblen effects noted by Quinn. Could be true.)
    So we have increased supply and reduced demand, leading in time to a reduction in the market clearing price.
    The reason that both Alex and I can be right is that we are talking about different parts of the market. Alex is saying that the price of non Fair Trade coffee should fall, I that the price of Fair Trade coffee will rise, thus lowering demand for it.
    Precisley, as you say, the effect of the branding.

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  12. Re Tim Worstall’s comment about Fairtrade flowers I presume that he’s referring to Felicity Lawrence’s decision not to buy Fairtrade-certified roses as described in her article in the Guardian http://www.guardian.co.uk/comment/story/0,3604,1431006,00.html

    The article is about the problem of defending the principles of Fair Trade when the big boys with disproportionate economic muscle choose to come on board.

    Felicity Lawrence confuses the issue in her article by suggesting at a couple of points that Fair Trade is an issue that concerns mainly small peasant farmers and their crops. (Just to be clear, I’m using the term “Fair Trade” to refer to the general issue and “Fairtrade” to refer to the certification procedure and mark administered by the Fairtrade Foundation).

    As a longstanding Fair Trade campaigner I’ve always been aware that that the Fairtrade Foundation’s certification criteria also deal with conditions of employment such as compliance with health and safety legislation, adequate housing provision, and educational provision for workers’ children on Fairtrade tea plantations, for example.

    Felicity Lawrence considers the working conditions of the labour force employed by the two certified flower growers in Kenya. She acknowledges that the conditions they complained of – excessive hours, casual contracts, poor housing, dangerous transport conditions and sexual harassment – have improved dramatically. However there is still a problem with compulsory overtime, particularly around periods of peak demand in western markets such as Mother’s Day – according to Lawrence the Fairtrade Foundation accepts that this issue is a problem.

    The aim of the Fair Trade movement as I understandd it is not simply to secure gains for what must ultimately be a minority of producers and workers supplying specialist brands. The long-term objective has always been to encourage major retailers, on the basis of the evidence of consumer support for ethical trading, to incorporate Fair Trade principles into their general purchasing arrangements.

    In March 2004 Tesco secured a lot of publicity for their inclusion of the UK’s first ever Fairtrade flowers in a new own-label range guaranteeing “a better deal for small producers in the developing world”. Tesco’s intention to become the “biggest seller of Fairtrade products in the UK” suggests that the success of Fairtrade-certified products has convinced them that the level of demand is sufficiently high to justify this policy commitment.

    However for Lawrence “the rose marks a turning point, a diversion down a road which, for the first time, I do not want to travel”. She sees the Fair Trade movement as facing the same dilemma that the organic movement had to face 10 years ago. When the supermarkets took on board the profitability of sales of organic products organic producers found themselves increasingly squeezed as supermarkets used their buying power to force down prices and through loss-leading promotion undermine the market price for organic milk.

    Cut flowers are a very profitable business for supermarkets. The problem for growers is that supermarkets leave it to the last minute to confirm the volume of their orders, making it difficult to plan production effectively, hence the imposition of compulsory overtime.

    So can the integrity of Fair Trade principles, involving respect for ILO labour conventions, national labour legislation, etc., be guaranteed if the demands of the big supermarkets conflict with some of those principles? That issue, Felicity Lawrence appears to be arguing, is exemplified by Tesco’s Fairtrade flowers.

    A comment from the Fairtrade Foundation might be more enlightening than my rather amateur interpretation of the situation but of course since it’s Fairtrade Fortnight at the moment their shoestring staff are stretched beyond the capacity to respond – as I’ve found when trying to order some additional materials.

    Finally, there’s another issue for the ethical consumer to consider as far as developing-country Fairtrade flowers are concerned – can the environmental cost of airfreighting flowers in to meet irregular peaks of demand in developed country markets be justified? As I see it this is a very minor aspect of a larger problem demanding remedial action at a global level.

    All the best

    Owen Beith (hope a contribution from another Owen B doesn’t bring too much confusion to the discussion)

  13. To be honest I can’t see that the supermarkets planning their purchases or not makes much difference. These are, after all, freshly cut flowers. Given the peaks and troughs of demand (whatever the supermarkets ordering processes) mean that coming up to Valentine’s and Mother’s Day the usual labour force will not be able to cope. There must be either extra hours worked or casual labour taken on. The problem ,if you think it is a problem, is that we as individuals consume flowers disproportionately on certain days of the year, and as cut flowers have a short self life, there’s just ain’t no way round variability in the demand for labour. Doesn’t matter if the supermarket tells them in November how many they need in Feb, still need more labour 1-12 Feb.

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