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Wednesday, May 03, 2006

The Fairness and Efficiency of 'Fairtrade'

This Project Syndicate article is by Peter Singer, a professor of bioethics at Princeton University who looks at Fairtrade and ethical production:

Why Pay More for Fairness?, by Peter Singer, Project Syndicate: Marks & Spencer, a ... chain with 400 stores throughout Britain, recently announced that it is converting its entire range of coffee and tea ... to Fairtrade, a marketing symbol of “ethical production.” ... It is also boosting its purchases of shirts and other goods made with Fairtrade cotton. ...

The movement toward more ethical consumption has made significant gains in the United States as well, as consumers increasingly turn to organic, locally produced foods, and eggs from hens not kept in cages. In the UK, a survey has found that half of those shown the Fairtrade symbol recognized it and understood ... it... There is no comparable US research, but related data ... suggests that the figure would be much lower.

Traders seeking Fairtrade certification must pay producers a price that covers the costs of sustainable production and provides a living wage. For example, the minimum price for coffee is $1.26 per pound, no matter how low the market price may fall. If the market price rises above that figure, the fair trade price will increase so that it remains five cents per pound higher.

Small farmers, for their part, are required to be organized in cooperatives or other groups that allow democratic participation. Plantations and factories can use the Fairtrade label if they pay their workers decent wages, comply with health, safety, and environmental standards, allow unions or other forms of workers’ associations, provide good housing if workers are not living at home, and do not use child labor or forced labor.

Not every one approves of Fairtrade. Brink Lindsey ... of ... Cato ... believes that the campaign for Fairtrade coffee is a “well-meaning dead end.” With some justification, he argues that the real cause of the fall in coffee prices was not the profiteering of multinationals, but big increases in coffee production in Brazil and Vietnam, combined with new techniques that make it possible to grow coffee with less labor and hence more cheaply.

In Lindsey’s view, if we want to assist coffee growers, we should encourage them either to abandon coffee and produce more profitable crops – and here he rightly points to rich nations’ trade barriers and subsidies as obstacles that must be dismantled – or to move into higher-value products, like specialty coffees, that bring higher prices.

What is curious about Lindsey’s argument, however, is that the Fairtrade coffee campaign can be seen as doing just what he recommends – encouraging coffee farmers to produce a specialty coffee that brings a higher price. Pro-market economists don’t object to corporations that blatantly use snob appeal to promote their products. If people want to pay $48 for a pound of Jamaican Blue Mountain coffee because that’s what James Bond prefers, economists don’t object that the market is being distorted. So why be critical when consumers choose to pay $12 for a pound of coffee that they know has been grown without toxic chemicals, under shade trees that help birds to survive, by farmers who can now afford to feed and educate their children?

Economists might reply that if you want to help people feed and educate their children, you can pay $10 for a pound of non-Fairtrade coffee that tastes the same and give the $2 you save to an aid agency that provides food and education to poor children.

That’s a possible strategy, but there are advantages to Fairtrade. The growers know that they have to provide a product that consumers like, both for its taste and for the way it is grown. If their product sells well, they can take pride in having produced something that is sought after around the world. From the growers’ perspective, receiving a premium by selling a Fairtrade product is preferable to receiving a charitable handout that they would get whether they worked or not and regardless of the quality of what they produce.

Paying more for a Fairtrade label is no more “anti-market” than paying more for a Gucci label, and it reflects better ethical priorities. Fairtrade is not a government subsidy. Its success depends on market demand, not political lobbying. Fortunately, in Europe, that market demand is growing rapidly. One hopes that it will soon reach similar levels throughout the developed world...

He says:

If people want to pay $48 for a pound of Jamaican Blue Mountain coffee because that’s what James Bond prefers, economists don’t object that the market is being distorted.

That's not quite correct. We worry a lot about distortions from product differentiation in monopolistically competitive market structures. We know that price will exceed marginal cost in monopolistically competitive industries even under a zero profit long-run condition, and there is often excess capacity within this type of market structure since production falls short of the minimum efficient scale.

But these inefficiencies are counterbalanced by the fact that market power, and hence "deadweight loss," is often small, and because monopolistically competitive industries satisfy our taste for product diversity and the gains from product diversity may be large. But analytics aside, economists do not overlook potential inefficiencies of this type.

Update: Greg Mankiw follows up and answers the question:

If you have a charitable motive, is it better to (1) distort your consumption patterns to buy more "good goods," or (2) satisfy your own desires in a self-interested way and donate the money you save to your favorite charity? When helping others, we should act as efficiently as possible in order to provide the greatest good to the greatest number. Does fairtrade coffee do that? Or does it just make the consumer feel better about himself? Singer's analogy that buying fairtrade coffee is like buying a Gucci label suggests the latter, although I know that was not his intention.

Another key question is why fairtrade is used to solve this problem when other seemingly more efficient solutions are available. The answer may lie in addressing the agency issues in fairtrade versus standard lump-sum charity arrangements.

    Posted by on Wednesday, May 3, 2006 at 12:33 AM in Economics, Market Failure | Permalink  TrackBack (0)  Comments (29)


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