Economics and politics - comment and analysis

How Fair trade can accomplish economic, social and ecological goals

Introduction

As I am writing up this article, in the North of Greenland temperature is 17.78 degrees C above average. Last week, it was – 14 C in Oslo and + 4 C in Spitsbergen, which lies well within the Arctic circle (see here). Incredible stuff is going on all over the globe (see here). Still, politically speaking, nothing of value happens. It is not only that the US dropped out of the Paris Agreement. It is clear by now that neither Germany nor the UK will reach their emissions targets by 2020. The system continues to greatly enrich the economic elite. ‘Populism’ and illiberal democracy threaten political, social, human and ecological rights, constituting no danger whatsoever to the elites of this world, the contrary is true.

“We have,” Monbiot writes, “used our unprecedented freedoms – secured at such cost by our forebears – not to agitate for justice, for redistribution, for the defence of our common interests, but to pursue the dopamine hits triggered by the purchase of products we do not need. The world’s most inventive minds are deployed not to improve the lot of humankind but to devise ever more effective means of stimulation (…) ensur(ing) that we all unwittingly conspire in the trashing of (…) the planet” (see here).

What can we do? If we have to wait until the countries get good on their Paris pledges, we can wait forever. If governments do not stand up, others have to. In this text, I am looking at the promises and challenges of Fair trade coffee. This is not a minor issue. Coffee is the second most tradable commodity after oil (see here). Coffee growing and processing has proven itself to be a lucrative industry. Over the year, several types of fair trade-type certification initiatives have emerged: fair trade helps farmers in the south, it stimulates social development and it is ’ecologically responsible,’ or, at least, that is the promise. In fact, there are a lot of problems with Fair trade. This is not a reason to be dismissive about it. There is a big discrepancy between the actual and the potential markets for Fair trade products. Markets for Fair trade products (not only coffee) would undoubtedly grow much stronger if potential customers would have access to accurate information about the precise ways in which these initiatives function and what their effects are on income, poverty reduction, community development, ecology and climate change. Agreed, it is not the ’best’ we can do. But the ’best’ is impossible to achieve. We should, for example, reduce and cancel debts, share technologies (making leapfrogging a reality), suppress intellectual property rights, rewrite patent laws, link development aid to both development – providing countries with the power to implement beneficial macroeconomic policies – and climate change mitigation and make all of it conditional upon democratisation, respects for human rights, the rights of women, the pacification of ethnic and religious communities and the fight against corruption. It is increasingly unlikely that any of this will happen. Let’s therefore see if Fair trade can make a real difference.

The context

Carbon markets connect developed and developing countries by creating new types of trade. Several authors have pointed towards the danger of ’carbon colonialism’ – a way for the northern countries to cheaply offset their emissions in the developing countries. In the light of this risk, in December 2015 at COP 21, Fairtrade International and Gold Standard, launched the Fairtrade Climate Standard that regulates Fairtrade Carbon Credits (FCCs). The FCCs guarantees a minimum price that covers production costs and a premium that is to be invested in environmental projects. The involvement of small scale producers in developing countries is essential. The Standard establishes criteria for production, trading and management. Only in this way, Fairtrade International asserts, the final result is not just only more trade.

Over the past decade, the number of FLO-registered producer organizations has grown rapidly. The majority of Fair Trade-certified organizations are located in Latin America and the Caribbean. Coffee growers’ organizations are the largest product group, accounting for about 35% of all registered producer organizations, but other products, including sugar and tea, are expanding (see here).

Traditionally, the more than 100 million people growing coffee around the world have been excluded from the huge profit making of coffee. On average, third world coffee farmers receive a paltry 10 per cent of the final retail price. As competition among growers has grown, the combination of price reductions and undercutting has left them more exposed than ever before. The drive for increased output also has had a knock-on effect on the environment, with mono-cropping and sun grown coffee becoming the norm (see here).

Traditionally, coffee is cultivated under a shaded canopy of trees, which provide habitats for indigenous animals and prevent topsoil erosion. The trees remove the need for chemical fertilisers. However, since the 1970s, sun-grown coffee has been produced in plantations with no forested canopy. As a result, fertilisers have become a necessity. The effect on biodiversity has been detrimental. In Central America alone, 2.5 million acres of forest, have been cleared to make way for coffee farming (see here). This link between coffee growing and deforestation has been highlighted by the WWF, who pointed out the fact that 37 of the 50 countries in the world with the highest deforestation rates are also coffee producers (see here).

While Fair trade focuses on the “ethical” side of coffee production, the Rainforest Alliance is more preoccupied with environmental concerns. It guarantees no minimum price for the growers. Instead, the organisation aims to conserve biodiversity and ensure sustainable livelihoods by transforming land use practices, business practices and consumer behaviour. Their standards forbid deforestation. No farm is certified if there is evidence of deforestation after 2005. Those qualifying for the certification need to implement a programme of re-forestation, develop shade grown coffee and forest non-productive areas of their farms (see here). The Rainforest Alliance certification system has become the choice of the key game players in the coffee industry with companies such as Costa and Kenco sourcing all of their beans from Rainforest Alliance certified farms. However, many of the big coffee brands have convoluted supply chains, which make it impossible for them to have any real idea of what’s going on down the line – a fact that makes a mockery of ethical and green claims. The bottom line is that one certification which guarantees sustainability and fair prices at the same time currently does not exist (see here).

The economics of Fair trade

Do the contractual modalities and the empirical realities of certification support the goals of Fair Trade schemes? Ana Dammert and Sarah Mohan’s provide an extensive literature review that shows several problems as well as promises (see here).

  1. Methodological considerations

Dammert and Mohan first deal with methodological issues. Many studies provide strong evidence regarding the positive impacts of Fair Trade, mostly on prices and farmers’ income. However, most of the empirical work relies on mean comparisons between different categories of farmers without controlling for the various factors that determine certification. This is poor, given that the estimates are likely to be affected by selection bias. If there is selection bias, the groups are not really comparable (see here). Comparing mean outcomes does not say anything about specific pre-existing characteristics that might have contributed for some cooperatives to go for certification and other to refrain from it. Furthermore, it is not possible to observe from the data what would have happened had farmers not participated in Fair Trade (see here).

Dammert and Mohan note another problem, this time with propensity score matching. Fair Trade certified producers are being paired with similar non-certified producers based on observable characteristics such as age, family size, farm tenure, and farm size, among others (see here). Some studies show no difference in price differentials, while others show negative selection into Fair Trade, which is what one should expect (and hope for), as small and disadvantaged farmers are being targeted. If there is negative selection (as several empirical papers suggest), estimates of propensity score matching are biased downward and thus understate the benign effects of Fair Trade (see here). Apart from that, as Dammert and Mohan write, unobservable characteristics may very well play a role (see here).

  1. Income

The great majority of papers that focus on price paid to the cooperative find a positive impact of Fair Trade. But, as Dammert and Mohan write, price paid is a weak indicator of producer welfare (see here). The guaranteed minimum price is generally not equal to the farm-gate price. It is the cooperatives, not the individual farmers, that receive the minimum price. Empirical studies show that the cooperatives often take deductions, for example to compensate for export credit costs or to pay down debt incurred to obtain certification, which is often significant. It has been reported, for example, that one-third of the total Fair Trade premium received was used to pay for certification in a Fair Trade coffee cooperative in Costa Rica (see here). This is bad because significant certification costs will exclude the poor from participating in Fair Trade. Apart from this, Fair Trade production is more costly than non-Fair Trade production.

As for price, Dragusanu and Nunn (2013) analyzed six coffee cooperatives from Costa Rica between 1999 and 2010 and found a significant but moderate price differential between Fair Trade certified farmers and conventional farmers of about $0.04 per pound on average (see here; see here for price differentials in the Swedish coffee market). According to Dammert and Mohan, the bottom line on income seems to be this: most early studies found a clear, positive, and significant correlation between certification and rising income (see here). Studies that control for selection bias find that the extent of predicted income gains from conversion to Fair Trade is small relative to gains fromother income generating initiatives, such as migration or employment in the rural non-farm economy. However, as Dammert and Mohan write, it should be noted that, even in a context of limited net income gains, Fair Trade certification still has an effect on household welfare, since the Fair Trade premium retained by the cooperative is meant to be invested in social projects (see here).

  1. Productivity growth

The effects of Fair trade certification on productivity remain unclear. Many papers suggest that Fair Trade and/or Organic certified cooperatives help farmers innovate more. There is a positive effect on capacity-building in farming techniques. This enables farmers to experiment with ways to improve productivity, quality and reduce costs. Some suggest this is a primary way that Fair Trade benefits the poor (see here).

Empirical work (all on Central America) shows that Fair Trade certified farmers sell more coffee than non-certified ones and that many Fair Trade or organic-certified farmers produced more than farmers holding both certifications. Other studies that meant to measure productivity as yield per hectare estimate that there is not much difference between conventional and Organic/Fair Trade (for example in Nicaragua). Of the empirical papers that control for selection bias, the evidence suggests that yields may be at least as important as prices, if not more so, in changing the profits that producers make. Indeed, in some cases yield differences account for at least two-thirds of the difference in the net revenue per hectare gap between Fair Trade-organic and conventional producers (see here).

  1. Market Access and Financial Assets

Dammert and Mohan’s review makes clear that many studies show that Fair Trade producers have more access to credit or savings compared to non-Fair Trade producers. This could be related to the fact that Fair Trade social premium finances “credit funds” (see here). These funds are particularly useful as banks often refuse credit to small-scale producers. Fair Trade producers were also less likely to need financing for the current harvest: 32% of Fair Trade had taken a loan in the last harvest, compared to 83% of conventional farmers. Of course – again – without controlling for differences between Fair Trade certified farmers and non-certified farmers, it is not clear if the greater access to credit for Fair Trade producers is due to Fair Trade or to the pre-existing differences that are correlated with access to credit (see here). Several studies show that Fair Trade producers have better assets, higher rates of savings and higher levels of animal stocks than their non-certified counterparts (see here).

  1. Labour, Education, Health and Reconversion

The FLO stipulates that plantations can hire labor and must pay them legal minimum wage. There is a dearth of studies on Fair Trade’s impact on labour. Dammert and Mohan only cites two. They both show that, although the salaries of Fair Trade workers are lower, they work fewer hours and obtain better fringe benefits (see here).

In addition to wages and employment, other factors affect labour outcomes. Fair Trade certification implies that the cooperative is maintaining minimum working conditions, freedom from discrimination, freedom of labour, compliance with minimum wages laws and prevention of employment of children below the age of 15 or the age defined by local law, whichever is higher. Given that an important fraction of children in developing countries are working in family farms, the FLO allows children under the age of 15 to work if they work after school or during holidays, the type of work is not dangerous or exploitative and the number of work hours is supervised by their parents (see here).

This sounds good, except that the increase of child labour can be positively correlated with Fair Trade certification due to an increase in the demand for family labour. At the macro level, higher demand for labelled goods might have a displacement effect in developing countries whereby adult workers replace children in the export sector while children replace adults in the domestic sector (see here).

Studies have established that farmers who had participated in Fair Trade networks for at least 6 years had a significantly lower disease incidence. Membership in Fair Trade cooperatives significantly increased the likelihood of receiving medical treatment when needed and Fair Trade farmers self-report lower food shortages and higher dietary quality than non-certified farmers. Other papers have found a positive correlation with Fair Trade certification and education outcomes. For example, it has been shown that Fair Trade farmers’ children are more likely to be currently studying at school and that Fair Trade farmers spend more on education (see here).

Finally, positing that horizontal inequalities (inequality between culturally defined groups) are biased against indigenous peoples and have particular relevance for explaining political violence, researchers found that Fair Trade, through its poverty-reducing impact, may have a positive influence on conflict prevention (see here).

Lastly, there is the discussion on the potential effects of price floors to general equilibrium market clearing if Fair Trade would become sufficiently large to impact world markets. This remains, for now, an ’academic’ discussion. However, if Fair Trade’s excess supply lowers the world market price of non-Fair Trade coffee, poverty levels of non-Fair Trade producers could potentially increase. At present, Fair Trade is too small relative to the world market to have such impact. Nevertheless, if Fair Trade succeeds to increase its relative size of the world market, the issue of excess supply will need to be addressed. Fair Trade leaders are aware of this and often publicly state the need to invest into training and diversification, rather than simply expanding production (see also here). Whether this is happening in the field is an open answer.

Conclusions

Dammert and Mohan conclude that Fair Trade has the potential to improve the welfare of producers in developing countries (see here). The effects on ecology and climate change mitigation will be presented in a follow-up article. In order to make Fair trade initiatives into a success on the criteria of social development and ecological goals, some redesigning is necessary in combination with assertive, open and honest communication with consumers and potential consumers so that everybody knows what is going on, where their money is going to, what is being done with it and what the economic, social and ecological consequences are.