I drank a cup of coffee this morning. Chances are you probably did too. It seems a coffee shop is located on every corner. In fact, coffee is the second most traded commodity by market value, behind only petroleum. Last week, when I was in the grocery store buying whole bean coffee, I became intrigued by what exactly the “Free-Trade” label means and what economics can tell us about the market impact of free-trade coffee.
To begin, many different “Free-Trade” certifications programs exist, including certification efforts by big companies such as Starbucks and Nestle. However, the Fair-Trade Labeling Organizations International (FLO) is the largest and most widely recognized certification system, and thus will be the focus of my discussion (source: The Market for Organic and Free-Trade Coffee). The FLO’s “mission is to connect disadvantaged producers and consumers, promote fairer trading conditions and empower producers to combat poverty, strengthen their position and take more control over their lives [link].” Those are laudable goals, but how does the FLO attempt to achieve those goals?
The FLO’s certification has three central criteria that must be met for a coffee to be labeled as free-trade (source):
1) The producer is guaranteed a minimum price depending on coffee grade (e.g. $1.26 per pound for washed Arabica). If the market price exceeds the price floor, then a price premium of $0.05-$0.10 per pounds is added to the market price.
2) The buyer provides credit to producers for up to 60% of the expected harvest value at the beginning of the growing season.
3) Buyers enter long-term (1-10 year) contracts with producers.
It is clear that these criteria help small, credit constrained coffee producers. Essentially, the long-term contracts and price floor give income stability by guaranteeing sales. In contrast, large coffee producers with access to credit can more easily withstand the coffee price fluctuations that occur frequently. By providing income stability to small coffee farmers, fair-trade advocates hope to eliminate speculative export middle-men and provide an equal playing field between small and large producers.
However, I pause to consider market impact of the price floor and market premium for fair-trade coffee. As an economist, the FLO’s fair-trade pricing criteria act as a subsidy, and recalling basic Econ 101, subsidies lead to over-production. That is, in terms of economic efficiency, should there be as many coffee farmers as exist today? The basic analysis says no. However, the real world is more complicated than Econ 101, and economics has little to say about equity and ethics. Today, this blog cannot answer the question “Is fair-trade coffee ‘good’ or ‘bad’?”; rather, I can tell you what fair-trade coffee is. Enjoy your cup of joe!