I was thinking of writing an op-ed for my school newspaper about Starbucks’ Fairtrade coffee and planned to use an old post by Alex Singleton as one of my reference points. In reviewing the argument that Mexican farmers benefit from Fairtrade at the expense of Ethiopian farmers, however, I found the economic analysis unclear.
Singleton notes that the price of coffee has experienced a downward trend, signally that too much coffee is being produced. He cites mechanization and World Bank loans as decreasing the cost of production. These historical facts mean that the supply curve has previously shifted downward, but they play no role in a partial equilibrium analysis of Fairtrade’s effects today.
As Mr. Singleton describes it, Mexican coffee producers are the marginal producers in the current equilibrium, due to their comparative disadvantage in the production of coffee (higher opportunity costs). A drop in demand would cause these marginal producers to exit.
Singleton argues that Fairtrade induces Mexican producers to stay in the coffee business and that if Mexican farmers switched to growing something other than coffee, Ethiopian farmers growing coffee would benefit. I think that this is incorrect.
Fairtrade is a manipulation of the demand curve, not the supply curve. Singleton agrees by describing participating consumers as willing to “pay a few pence extra for a cup of coffee.” Therefore, the abolition of Fairtrade would cause consumers to offer a lower price at each quantity. This is a downward shift of the demand curve.
How does a downward shift in demand affect the supply curve? There is a change in quantity supplied, but not a change in the supply curve itself. As such, the marginal producers (Mexican coffee growers) will exit until equilibrium is reestablished. Does this help the Ethiopians?
Facing fewer competing firms may sound appealing at first, but it’s not beneficial if competitors exited due to insufficient demand. Under Fairtrade, producers that export coffee at a cost below the market equilibrium price earn profits; this is the traditional producer surplus triangle. If it is true that Ethiopians are these lower cost producers, then they will remain in the market when demand falls, but their producer surplus will be reduced. The shaded rectangle is the welfare loss Ethiopians experience due to lower demand. The abolition of Fairtrade and exit of Mexican producers corresponds to lower profits for Ethiopians.
Of course, my analysis up to this point has treated coffee as a unified market. In fact, Fairtrade coffee comprises a small portion of total coffee consumption, so we have to draw separate supply-and-demand graphs for unsubsidized and subsidized coffee, which are substitutes.
Foregoing the actual illustrations, as one can easily imagine them, let’s analyze the effect of increasing Fairtrade participation by consumers. This is an upward shift in the demand curve for Fairtrade coffee. However, as Fairtrade coffee substitutes for unsubsidized coffee, the change in consumer preferences causes a downward shift in the demand curve for unsubsidized coffee.
What are the effects upon producers? Producer surplus will increase in the Fairtrade market and decrease in the unsubsidized market. Thus, the result in ambiguous. Those suppliers that are Fairtrade-certified benefit, whilst non-participants lose profits. If Mexicans are more easily able to form a producer organisation eligible for the Fairtrade label (groups exporting more than 44,000 pounds of coffee per year and able to pay the $2,431 fee) than Ethiopians, then they will benefit at the expense of their African competitors. But if Ethiopians are able to join the Fairtrade program as easily as other coffee producers, then we should not expect Fairtrade’s inflation of the demand curve to have disproportionate negative effects upon them.
The only way for Fairtrade to do no harm to coffee producers would be for all of them to participate. Non-participants do face reduced demand for their product. In its current form, Fairtrade may or may not be net benficial, depending upon the elasticities of the relevant curves and one’s willingness to make interpersonal utility comparisons.
[Comments are open; please post suggestions and corrections.]