Fair trade, coffee prices, and farmer incomes

This is my second post on Fair Trade (see my earlier post here). Having established in the previous post that sustainability labels matter for consumers (at least according to the study I reviewed in that post), the question is whether Fair Trade matters for farmers. Does it increase the prices they receive by enough to offset the certification costs? Does it increase farmer incomes?

The basic mechanics of the Fair Trade pricing system work like this: farmers receive a stated minimum price for coffee or the market price, whichever is the greater. They also receive an additional premium, which is to be used only for social or business development purposes, as democratically determined by members of each cooperative.

A recent paper (ungated longer and earlier version here) by Alain de Janvry (UC Berkeley), Craig McIntosh (UC San Diego), and Elisabeth Sadoulet (UC Berkeley) argues that easy (not quite free) entry into the supply of fair trade coffee eliminates any premium that coffee producers receive from being Fair Trade certified. Since the barriers to entry into Fair Trade production are relatively low, if the Fair Trade premium is high many producers seek to become certified, competing with the existing suppliers for a limited market for Fair Trade coffee, and reducing the proportion of each supplier's coffee that is sold at the Fair Trade premium (effectively reducing the average price received).

This outcome is driven by the actions of the certifiers. Because the certifiers only source of income is to provide certification, the incentive is for them to over-certify relative to the number of certified farmer cooperatives that would maximise farmer profits. Since the farmers pay for the certification, de Janvry et al. argue that the result is:

...that the price premiums in the FT system have largely flowed toward certifiers rather than producers as intended by the consumers of FT coffee.

They demonstrate their results using data from Coffeecoop, a Central American association of coffee cooperatives where all coffee is Fair Trade certified, over the period 1997 to 2009. However, because not all Fair Trade certified coffee is sold as Fair Trade, the authors can compare Fair Trade prices with non-Fair-Trade prices for the same batch of coffee, which allows them to control for quality (which is an important determinant of coffee prices).

They show that:

...the nominal premium was quite significant in the years 2001 to 2004 with low NYC price, reaching an average of 60c to 64c per pound over a market price of 63c per pound but falling to 5c to 9c per pound over a market price of 126c per pound from 2006 to 2008, even though the social premium in these years should have been at least 10c per pound.

That seems quite good overall, until you consider what happens to the proportion of coffee sold as Fair Trade, where they confirm that the sales share moves inversely with the Fair Trade premium (i.e. when the premium is high, the cooperative is able to sell a lower share of coffee as Fair Trade). The overall result is that:

The average effective premium over the thirteen years of our data is 4.4c per pound over an average NYC price of 107c per pound, and only 1.8c per pound over the last five years, 2005 to 2009.

And when they consider the costs of certification, which they estimate at 3c per pound:

...the average result of participating in the FT market has been only 2.5c per pound for the whole period of observation and with a loss of 1.2c per pound over the last five years.

You may consider that as only one result based on a single case study, and while it looks at prices at the cooperative level, it doesn't look at the effects at the farmer's level.

Ana Dammert and Sarah Mohan (both Carleton University) recently reviewed the literature on the economics of Fair Trade in the Journal of Economic Surveys (ungated earlier version here). They point out that establishing the impacts of Fair Trade for farmers is not straightforward - there is likely to be a selection bias, since farmers who expect to do well out of certification are more likely to choose to become certified. Few studies have accounted for this well, and those that have done have mostly used some form of propensity-score matching, where they essentially compare farmers that are certified with those who aren't but otherwise look very similar to the certified farmers (e.g. same size farm, same land quality, same education, same farm assets, etc.).

In terms of these higher-quality studies, the one study using this approach to look at prices found no evidence of increases in prices received by farmers. And for incomes, there are some gains but those gains are small relative to alternative income generation activities for rural dwellers like migration or employment in the rural non-farm economy. Having said that, they also find that:

Another strand of the literature accounts for selection bias and shows that Fair Trade producers have better assets, higher rates of savings and higher levels of animal stocks and perceive their land as having high renting value...

That is difficult to reconcile with little increase in incomes. So, it's possible that there are small gains for coffee farmers from Fair Trade certification. However, it's hard to say that those gains justify the much higher prices that coffee consumers pay (although the consumers do receive a 'warm glow' benefit as well).

Finally, maybe some of the other labelling initiatives are better for farmers than Fair Trade? Consumers were willing to pay more for Rainforest Alliance labelling than Fair Trade, after all. I'll return to this last point in a future post.

Read more:

• Sustainability labels do matter