Understanding Fair Trade

Fair Trade is a social initiative that attempts to aid small producers and workers in developing countries, by offering them better terms of trade and helping them to organize, both economically and politically.  It works through a certification system overseen by nongovernmental organizations, such as Fairtrade International.   A certified product signals to consumers that producers were paid a minimum price and that the product meets specific requirements for certification.  Most of the products are commodities, including coffee, tea, cocoa, flowers, sugar, fruits, gold, and honey.  Coffee has received most of the attention from research due to the large number of producers located in various developing countries.  Over time, researchers in economics have asked important questions about the effectiveness of Fair Trade in achieving its proposed economic development goals and the long term implications of the certification system.
Fair Trade sceptics are concerned about the distortions that price floors and the requirement that firms be ‘small’ to qualify for benefits introduce to incentives.  For example, it has been argued that producers will not seek to improve their production methods because remaining small enables them to keep Fair Trade certification (and the rents from the price floor). This perpetuation of inefficiency, it is argued, will prevent them from lifting themselves out of poverty. Sceptics also claim that a higher price can lead to over-supply and create additional distortions in the world market.
One response to the latter criticism is a theoretical model showing that when a Fair Trade certified product is treated as a differentiated product, with distinct supply and demand curves, and the number of Fair Trade contracts satisfies demand, the certification system does not result in over-supply.  If the intermediaries buying the certified products are oligopsonistic, the Fair Trade system enables producers to recover profit from the intermediaries.  Although this model, as well as other models in the literature, rely on the assumption that consumers care about the production process being socially or environmentally responsible, the market outcome improves without introducing additional distortions.  Other economic models that explore how free entry dissipates rents in the long run derive different conclusions. One model shows that, if demand is inelastic, producers have an incentive to continue entering the market until the expected benefit of Fair Trade certification equals the cost of acquiring it.  This means that the rents from the price floor are channeled towards the costs of certification, which would defeat the purpose of Fair Trade in helping poor producers.  However, this detrimental outcome is not assured in an environment where there are barriers to entry, such as an upper limit to firm size.
Finally, there are methodological issues related to the empirical evaluation of Fair Trade.  It is well documented in the literature that certified producers sell and produce more with better quality than non-certified ones.  However, it is unclear whether there is an omitted variable that causes them to produce more or, alternatively, whether the certification itself causes them to perform better.  Moreover, it is unclear what is driving producers into the certification process.  On the negative side, they are small, have limited access to credit, and limited market access.  On the positive side, they are found to be more entrepreneurial, have better organizational skills, and are more willing to co-operate with others.  This mix of findings suggests that some aspects of Fair Trade and its consequences are not yet well understood and more research in the topic is necessary.
Booth, Phlip and Linda Whtstone (2007) “Half a Cheer for Fair Trade,” Economic Affairs, 27 (2): 29-36. [working paper]
Collier, Paul (2007) The Bottom Billion, New York: Oxford University Press.
de Janvry, Alain, Craig McIntosh and Elizabeth Sadoulet (2015) “Fair Trade and Free Entry: Can a Disequilibrium Market Serve as a Development Tool?The Review of Economics and Statistics, 97 (3): 567-573. [working paper]
Dragusanu Raluca and Nathan Nunn (2015) “The Impacts of Fair Trade Certification: Evidence From Coffee Producers in Costa Rica,” Working Paper
Dragusanu, Raluca, Daniele Giovannucci and Nathan Nunn (2014) “The Economics of Fair Trade,” Journal of Economic Perspectives, 28 (3): 217-236.
Griffiths, Peter (2012) “Ethical Objections to Fairtrade,” Journal of Business Ethics, 105 (3): 357-373. [working paper]
Podhorsky, Andrea (2013) “Certification Programs and North-South Trade,” Journal of Public Economics 108: 90-104.
Podhorsky, Andrea (2015) “A Positive Analysis of Fairtrade Certification,” Journal of Development Economics, 116: 169-185.