The economics of 'Fairtrade': is it worth the mark-up?

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This was published 6 years ago

The economics of 'Fairtrade': is it worth the mark-up?

By Caitlin Fitzsimmons
Updated

How do you feel about slavery and exploitation? Like most people, I'm not a fan.

How do you feel about being ripped off? I hate that too!

Illustration: Simon Letch

Illustration: Simon Letch

I'm willing to pay a little more to ensure suppliers are treated fairly, but I don't want businesses to exploit my generosity to boost their own profits.

So I'm interested to apply an economic lens to initiatives such as Fairtrade to see how they work.

Illustration: Andrew Dyson.

Illustration: Andrew Dyson.

Fairtrade is a specific certification that ensures fair prices are paid to farmers in the developing world and I've seen the benefits firsthand for coffee farmers in countries such as Uganda.

Subsistence farmers on small plots of land typically grow food for their family and a bit of coffee on the side as a cash crop. Income from coffee pays for things such as school fees, clothes, mosquito nets and cooking oil.

The problem is the price of coffee fluctuates. Coffee is a commodity traded on an exchange, the same as gold or oil, and subject to the laws of supply and demand. Growing coffee is a decent income stream when prices are high, but there's always the risk of making a loss.

The name of the game for coffee farmers is to value add – if they adhere to certain standards and gain a certification such as Fairtrade or others such as Rainforest Alliance or organic, they can get a better price. Auditors often certify for more than one label at a time.

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The mark-up on Fairtrade coffee at a cafe shouldn't be much.

The mark-up on Fairtrade coffee at a cafe shouldn't be much.

In Uganda I saw the difference it makes. In areas producing plain commodity coffee, the farmers laid out the harvest to dry on a tarp and I often saw green and overripe coffee cherries mixed in the crop because the price wasn't high enough to care about quality. On farms working with Fairtrade and also organic certification, I saw the soil nurtured with manure and mulch, trees providing homes for monkeys and birds, and community facilities funded through the Fairtrade Premium.

Fairtrade Australia & New Zealand chief executive Molly Harriss Olson explains that Fairtrade sets a minimum price at or above the cost of production. As you can see in the graph, if commodity prices are below the cost of production, the Fairtrade price is a flat line, so farmers never sell at a loss.

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There's also the Fairtrade Premium. When commodity prices are above the cost of production, the Fairtrade price is a squiggly line a few percentage points above the traded price.

The Fairtrade Premium is paid to the whole community rather than the individual farmer. Fairtrade also certifies other commodities including cocoa, cotton and sugar.

So far so good, but how do the economics work?

The conventional model says demand is higher when prices are low and supply is higher when prices are high. I'm not sure about the former – if you halved the price of coffee, personally I wouldn't drink twice as much of it.

But price definitely affects the supply side. If prices are high, farmers grow more of the crop. That in turn can lead to oversupply and then a crash in the price.

For example, coffee prices were high in the 1980s, but in the following decade Vietnam became a major coffee exporter, increasing production by 1400 per cent. When the price of coffee inevitably fell, it hurt smaller coffee producers in other countries.

The phenomenon is explained by the "cobweb theorem", as described by economist Nicholas Kaldor in 1934, citing earlier analysis of hog production by German economists. It describes how supply and demand in agriculture is never fully in sync because of the lag between planting and harvesting. You can equally apply it to explain, say, construction of apartments completed after a property boom is over.

Harriss Olson says Fairtrade works hard to expand the market for Fairtrade-certified produce but agrees market shifts are a constant challenge. A recent example: Fairtrade sugar growers in Fiji saw a calamitous collapse in demand because European Union regulations shifted to favour beet sugar grown in Europe.

So Fairtrade has limits: it can guarantee a minimum price and a premium in the event of a sale, but it can't guarantee a buyer. That's OK, its effect is still positive.

The other end of the equation is when you buy a Fairtrade product. You can have a high degree of confidence when dealing with a respected charity such as Oxfam, but what about a business?

Say you go to your local cafe and buy a cup of Fairtrade coffee. How do you know if the price is fair?

First, check to see if it's actually certified, carrying the logo of Fairtrade or another scheme. Harriss Olson says companies often label things "fairtrade" or "fair trade" or "fairly traded" when it's not true.

Second, how much extra is being charged? A huge mark-up should ring alarm bells.

Financial Times journalist Tim Harford, in his book The Undercover Economist, describes how in the early 2000s British cafe chain Costa Coffee was charging £1.85 for a cup of Fairtrade coffee and £1.75 for regular coffee.

The beauty of Fairtrade is that the entire supply chain is transparent, so Harford knew the extra cost for Costa was about 1p per cup of coffee. He made inquiries and sure enough, the extra 9p was pure profit for Costa.

Costa was exploiting Fairtrade to get closer to what economists call "variable pricing", whereby each consumer is charged what they're willing to pay.

But the transparency of the Fairtrade system meant Costa didn't get away with it. Soon after Harford made his inquiries, Costa decided it was better PR to offer Fairtrade coffee at no extra cost.

It's worth being a sceptical consumer – and telling an economics journalist like me if you see anything dodgy.

There was nothing illegal in Costa's mark-up, but if it damages trust in Fairtrade, poor farmers pay the price.

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You can have a conscience without being a sucker.

Ross Gittins is on leave. Caitlin Fitzsimmons writes columns on work, life and money. Find her on Facebook and Twitter.

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