Tuesday, 5 April 2011

Fair Trade or Free Trade: An Economic Analysis

1. Introduction

Ending poverty worldwide is a noble goal. This work discusses the means by which we can achieve this goal. I show that buying Fairtrade certified products is not an efficient way of achieving this goal and that buying Fairtrade products may be doing more harm than good. I argue that directly donating to aid organizations is a more effective means of getting charity into the hands of those who need it most: the world’s very poorest people.  I will further show that the most effective way to achieve the goal of ending or alleviating poverty is through simple free trade, with consumers buying what they want without regard to the spurious notion of “fair trade”.

2. Free Trade vs. Coerced Trade

There is a clear distinction between a trade (i.e. an interpersonal exchange) that is made by two consenting parties, and a trade that involves the coercion by one party of another. The former is a voluntary trade; both individuals freely choose to make the trade, because they expect to benefit from it. The latter is a coerced trade; one party does not consent, because they do not expect to benefit from it, but they are coerced into making the trade anyway by the use or threats of violence.

The vast majority of trades are voluntary. Coerced trades include theft, fraud, robbery, assault, slavery, rape and murder. Taxation, regulation, prohibition, conscription and war are examples of coerced trades conducted by governments. A free market is a market where all trades are voluntary, i.e. there are no coerced trades.

3. Fair Trade vs. Unfair Trade

The Fair Trade Movement makes a distinction between two types of free trade, which they call “fair” trade and “unfair” trade. A typical example of an “unfair” trade is a poor third-world worker being paid a very low wage and working long hours in an unsafe factory environment. It is clear that, unlike the distinction between voluntary and coercive, the distinction between fair and unfair is completely arbitrary and subjective. It is a third-party opinion about a trade that is nothing to do with them. What is considered “fair”, a “decent” or “living” wage, “reasonable” working hours and safety conditions, differs from person to person, place to place, and time to time.

The poor third-world worker is voluntarily employed; this is a free trade. Therefore he must prefer being employed over his other options. If the worker had a more preferred option available to him, he would simply choose that option instead. If he was prevented from choosing his preferred option of being employed at a factory producing shoes, say, he would obviously be made worse off. The most extreme example would be a worker in the most severe situation of poverty, where he has “has no other option”: either he works in the shoe factory, or he starves to death. Here it is clear that preventing him from working in the factory would be tantamount to condemning him to starvation.

A trade may be considered “unfair” by well-meaning Westerners, but that the trade is free (i.e. uncoerced) is proof that both parties to the trade expect to benefit from it, and consider it their preferred option. The parties to any given free trade, who are the only individuals of importance, by definition do not consider it to be “unfair”.

4. Means of Preventing “Unfair Trade”: 1. Coercion

The Fair Trade Movement is part of the more general “Trade Justice” philosophy, which has overt political ambitions. The goals of the movement are to hamper the free market economy using various kinds of government legislation, including:
  • Isolationist policies; tariffs and other trade barriers.
  • Global regulation and management of trade and production, including standards on working conditions and wage rates.
  • Trading agreements (cartels, such as the defunct International Coffee Agreement) that will set national export quotas for global commodities.
Harriet Lamb, Director of the Fairtrade Foundation, stated in 2008 that “Fairtrade also plays a more practical role in building a broad-based movement for change… Fairtrade is an easy way in… It helps give our governments a mandate to take the big, bold steps needed to change world trade rules.”[1]

The economists of the Austrian School have shown how the effects of government intervention on the market economy can only cause impoverishment.[2]

5. Means of Preventing “Unfair Trade”: 2. Persuasion

Not all Fair Trade advocates support the use of government to end what they consider to be “unfair” trades. They wish to appeal to individual consumers to change their spending habits, from buying cheaper brands of products to buying more expensive products that have been certified as being produced only through “fair” trades.

The largest certification agency within the Fair Trade Movement is the Fairtrade Foundation, formed in 1992 by a coalition of charities, including Christian Aid and Oxfam. The Fairtrade certification mark is licensed to appear on products that are judged to have met certain standards in the treatment of producers, derived from the Fair Trade philosophy, including requiring them to form cooperatives and also offering a fixed lowest price for their goods.

The idea is to persuade people to value the Fairtrade mark sufficiently so that they choose to spend a little extra for a product identical to a cheaper product which lacks the Fairtrade mark. The extra money is supposedly worth it for the satisfaction of knowing that no worker in the production line of that product has been treated “unfairly”. The consumer buys the Fairtrade product believing that their extra money paid is going to the poor workers who produced that product: a little bit of charity on top of the normal wage rate for the worker. For example, suppose a particular coffee costs £4, and an otherwise identical product that has been certified by Fairtrade is £5. The £1 difference is the charitable donation the consumer is making.

6. Fairtrade as Charity

For any charitable donation, two important considerations are:
  1. Who is the desired recipient? And
  2. How much of the donation gets to the desired recipient?
To begin with the second question, out of a £1 Fairtrade charitable donation, only 10p reaches the intended recipients – the producers – with 90% going to retailers.[3] This contrasts with most direct charities such as Oxfam and the Red Cross, where between 70% and 95% of their donation income reaches the intended recipients.[4] So Fairtrade is a very inefficient method for delivering charity.

The Fairtrade Foundation competes with all other charities for donations, so increased demand for Fairtrade products will tend to lower the overall amount of charity that is delivered, all other things (i.e. the total amount of charity) being equal.

With regard to the first question, while Fairtrade benefits producers who sell Fairtrade certified products, it does so at a high cost to producers who are not Fairtrade certified. As an example, 25% of Fairtrade coffee comes from Mexico, which has 51 Fairtrade certified producers. Ethiopia has only 4 Fairtrade certified producers, despite 80% of the population working in agriculture, earning an average of $700/yr, compared to 18% of the Mexican population working in agriculture on an average wage of $9,000/yr.[5] The desperately poor Ethiopians suffer due to Fairtrade, with the benefits going to relatively wealthier Mexicans. Fairtrade charity does not reach the poorest producers. It benefits the few relatively wealthy producers who meet Fairtrade standards, at the expense of the many less-wealthy producers who do not.

In short, Fairtrade is charity that is delivered inefficiently and does not reach the poorest members of society. This can be contrasted with direct forms of charity, which deliver a higher proportion of the donation, and specifically deliver it to the desired recipients: the poorest members of society.

One final argument made in favour of Fairtrade is that if people did not buy Fairtrade products, they would not give the money saved to a direct charity, but would spend it on themselves instead. With Fairtrade, giving to charity is easy. So even though Fairtrade charity is inefficient and misdirected, it still increases the total amount of charity, and this can only be a good thing.

However, this is a generalization beyond merely an argument for Fairtrade products. Clearly if the consumer decreases their direct charitable donations in order to switch to Fairtrade products, the total amount of charity delivered decreases due to the inefficiency of Fairtrade, and this is contrary to the goal of the Fairtrade advocate. For this argument to apply, the Fairtrade advocate must convince consumers to increase their total charitable donations, in which case one wonders why they would not just advocate for a direct charity, which is more efficient.

With regard to Fairtrade being “easy” charity, such that it might induce higher total donations, it is equally easy for direct charities to make deals with consumer brands such that part of the price of the product is delivered to charity. This already happens extensively: charitable donations by businesses and corporations take this form – corporate donations may be the easiest form of charity of all from the consumers’ point of view – and it is common to see products advertised by companies promising to deliver a small part of the price paid, or a portion of their profits, to charity.

7. Free Trade as a Poverty Alleviator

Free trade is the most effective poverty reduction strategy the world has ever seen. The free market process is a wealth-generating engine: no government intervention into the market can add to prosperity, wealth, growth or development. This free market process was recognized by early economist Adam Smith as almost miraculous: he called it the “invisible hand” which guides free individuals towards maximising the prosperity of other individuals, purely by pursuing their own self-interest.[7]

Ludwig von Mises and other economists of the Austrian School have carefully elaborated how the market process works.[8] The “invisible hand” is nothing more than free market prices, which guide the actions of entrepreneurs seeking profits.[9] Entrepreneurs respond to the information in prices by rearranging the structure of production (the uses of land, labor and capital) in such a way that resources are used in a way that maximises the desires of consumers. Profits and losses serve as vital signals to entrepreneurs, informing them of where more resources are required, and where resources are being wasted, and also providing as an incentive for them to make the required adjustments to the structure of production.[10]

The market process works as follows:
  1. Prices are determined by supply and demand; the market price is the price that allocates the available supply to where it is most demanded.
  2. If there is an increase in demand (or a decrease in supply) for a product, the market price will increase; businesses raise prices, otherwise they will have a shortage of the product.
  3. The increase in price results in increased profits to the business.
  4. In response to the increased profits, existing producers shift more resources toward production of that product, and newcomers are attracted into that line of production.
  5. In this way, supply increases in response to a greater need for the product.
Conversely, if demand for a product falls (or supply increases), entrepreneurs are impelled by competition to lower their prices. The decreased profits or losses result in entrepreneurs shifting resources away from their current use and towards producing something in greater demand.

Prices constantly adjust to changing supply and demand conditions, and ever-alert entrepreneurs stand ready to shift resources so that they are being used in the most productive way possible. The entrepreneurs do this purely out of self-interest, and are highly motivated to do so. Competition impels excellence, as entrepreneurs failing to use resources efficiently for satisfying consumer demand lose out to their competitors and become bankrupt; the market process ensures that resources get into the hands of the most capable entrepreneurs: those satisfying consumers the best.

Any use of coercion is sure to hamper the market process, because prices are disrupted and the profit and loss signals no longer reflect what consumers really want.[11] Entrepreneurs are misled into making malinvestments of resources from the point of view of consumers; resources are wasted.[12]

Wealth comes from productivity; the efficient use of resources. The average American is richer than the average African, because the American is more productive. The average 21st century American is richer than the average 19th century American because the modern American is more productive. This is not because modern Americans work harder than Africans or their ancestors, but because they have more capital goods available – more machines and better technology – which enables them to be more productive, to engage in greater diversification and specialization, and therefore to reap greater benefits from the division of labor and knowledge.[13]

A lack of wealth – poverty – therefore, is caused by a lack of productivity, so the only means of alleviating poverty is to increase productivity through capital investment. Free trade is the most effective means conceivable of increasing productivity, and hence alleviating poverty.

8. The Effect of Fairtrade on the Market Process

Having outlined how the market process works, we are now in a position to examine the effects of buying Fairtrade products. How does this affect prices, the signals that coordinate efficient production? Do the poorest members of society benefit from the way entrepreneurs will arrange the structure of production as a result of high sales of Fairtrade products?

Let us suppose that a firm or entrepreneur is looking to build a new shoe factory, say, and he is considering where to build it: country A or country B. Country A is very poor, and the entrepreneur estimates that he will be able to find people in country A that will accept employment in his factory for a wage of just $1 per day. Country B is less poor, and because of this, the people have better alternative employment options available to them, so the entrepreneur estimates that he will have to pay a wage of $4 per day to entice people in country B to work in his factory. So, all other things being equal, an entrepreneur keen to maximise his profits by keeping his costs down will choose to build his shoe factory in country A.

Now let us suppose that consumers are convinced of the benefits of buying Fairtrade goods. The shoe producer recognizes that he will not be able to sell shoes profitably unless he gets a Fairtrade certificate. And suppose that in order to get that certificate he will have to pay “fair” wages of $5 per day to his employees.[14] Now, which country will he build his factory in? All other things being equal, there is no particular reason for him to invest in the poorer country; his wage costs will be the same wherever. Furthermore, the poorer country may have inferior security or infrastructure or less educated workers compared to the less-poor country. So with wage-costs being equal, the entrepreneur will build his shoe factory in the less-poor country.

With consumers unconcerned by whether workers have been paid a “fair” wage, investment is directed towards the very poorest areas, rather than areas that are less poor. When well-intentioned consumers buy Fairtrade products thinking they are helping to alleviate poverty, they are unwittingly doing the opposite: they are inhibiting the process that alleviates poverty.

When one shoe company starts making strong profits by paying people in country A just $1 per day, other companies will be attracted to the area to compete with them. Another shoe company might open a factory nearby and offer $2 per day, enticing workers to his factory instead. In this way, the wage rates of the workers are bid up through competition. The poverty of the workers is reduced. Compare this to the case when consumers demand Fairtrade products. The profit-seeking entrepreneurs have no incentive to invest in the very poorest countries, because they must pay workers there as much as workers anywhere else. So there is no incentive for investment in the area and the very poor people must stick with their current occupations, which are worth less than $1 per day to them. The poverty of the workers endures.

The alleviation of poverty requires capital investment in poverty-stricken areas, to increase the productivity of the workers. As a result of the trend for Fairtrade products, poverty is greater than it would otherwise have been, because capital investment has been directed away from the most poverty-stricken areas, while without the fetish for Fairtrade products, capital investment would have been directed toward them.

9. Conclusion

Free trade is the greatest possible means of alleviating and eliminating poverty. The free market process does this best when consumers seek the best price they can get for the goods they buy, without any concern about the wage rates of workers that produced those goods. Buying Fairtrade goods inhibits the process which alleviates poverty.

To buy Fairtrade goods is to donate to charity, but charity delivered in this way is highly inefficient and does not actually reach the very poorest workers, who are presumably the intended recipients.

Some members of the Fair Trade Movement seek to use coercion by governments as a means to prevent their highly subjective and arbitrary notion of what constitutes “unfair trade” from taking place. They seek to prevent poor people from working jobs they have chosen voluntarily, failing to realise that this will leave them worse off and condemn them to their tragic situation of poverty.


[1] Harriet Lamb, Director of Fairtrade Foundation (2008), quoted in Marc Sidwell Unfair Trade (2008).
[2] See Henry Hazlitt Economics in One Lesson (1946) or Murray Rothbard’s Power and Market (1970).
[3] 'Voting with your Trolley', The Economist, 7th Dec 2006.
[4] According to charitynavigator.org, which monitors American charities, Oxfam (80.1%), Unicef (91.8%), American Cancer Society (72.8%), Save The Children (91.7%), American Red Cross (91.8%), World Vision (86.7%), etc, all spend the majority of their donation income on charitable programs.
[5] Marc Sidwell Unfair Trade (2008).
[6] Most economists agree that minimum price controls cause surpluses, so minimum wage legislation cause surplus labour, i.e. permanent unemployment, which harms the poorest members of society. For a clear explanation of how government manipulation of prices inhibits prosperity, see Henry Hazlitt’s Economics in One Lesson (1946).
[7] Adam Smith The Wealth of Nations (1776).
[8] Ludwig von Mises Human Action (1949) and Murray Rothbard Man, Economy and State (1962).
[9] For an illustration of the importance of coordination of economic activity, see Leonard Read I, Pencil (1958).
[10] For a brief examination of how profits and losses serve as signals for coordination, see Ludwig von Mises Profit and Loss (1952). For a critique of an economy lacking profit and loss signals, see Ludwig von Mises Socialism (1922).
[11] See Murray Rothbard Power and Market (1970).
[12] For example, a minimum price control causes a perpetual surplus of the product, regulations and prohibitions causes increase costs of production, a sales tax causes artificially high prices of all affected goods, bailouts prevent misallocated resources from being freed up to be put to better uses or by more capable hands, monetary inflation causes the interest rate to be distorted resulting in boom-bust cycles, wars and military spending cause resources to be used to produce tanks, bombers, mortars and missiles rather than goods more demanded by consumers, and so on.
[13] For example, in modern America advanced agricultural machinery makes each farmer more productive and this frees up workers for producing other goods. In modern America, only a very small proportion of the population are is employed in agriculture, relative to Africa or 19th century America.
[14] These values are purely illustrative. I have also simplified in that there are many other stipulations required to get a Fairtrade certificate; these will add to the effects described.

1 comment:

  1. Graham, I have some questions about your article on: http://fairtrade-eerlijkehandel.blogspot.com/2011/04/questions-about-fair-trade-or-free.html