Bachelorthesis

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Bachelorthesis

Will the development of Fairtrade production increase sustainable economic growth in a developing country?

Sustainable GDP

Development Fairtrade Bachelor Economics - FEB

Eefje de Gelder

s402285

June 2010

Supervisor: dr. G.C.L. Vannoorenberghe - Department of Economics

Outline

Preface 3

Chapter 1: Introduction to Fairtrade 4

1.1. Visions and objectives 4 1.2. Short history 5 1.3. Visual representation of trade process 6 1.4. Fairtrade and economic growth 7

Chapter 2: Fairtrade principles and research on economic growth 8 2.1. Fairtrade price 8 2.2. Fairtrade premium 14 a. Education 14 b. Health care 16 c. Farm improvements and other process facilitation investment 17 2.3. Empowerment producers and workers 18 a. Transparency and democracy 18 b. Contracts and partnerships 19 c. Hired labor and working conditions 19 2.4. Provision finance 21 2.5. Sustainable development 22 2.6. General comments 24 2.7. Conclusions on Fairtrade principles and research on economic growth 24

Chapter 3: Empirical research – coffee market 25 3.1. Coffee market 25 3.2. Fairtrade price 26 3.3. Fairtrade premium 30 3.4. Empowerment producers and workers 30 3.5. Provision finance 31 3.6. Sustainable development 31 3.7 Conclusions on Fairtrade coffee and impact on economic growth 32

Chapter 4: Conclusions and final remarks 33

Appendix 35

References 40

Preface

„Aid to developing countries is nonsense and doesn‟t work at all‟, so is the general opinion often heard in my family. At home we often buy Fairtrade products, since we perceived them to be more effective in helping the poorest. Once living on my own, I continued buying the products if my budget allowed me to do so. Moreover, the question “will it really make sense me paying 50 cents more for my coffee and tea” has always been triggering me. In addition, during my study at Tilburg University and Universidad de Navarra the question „what causes economic growth in developing countries to go up, and hence foster well-being for the poor?” (Ulrich, 2010) got increasingly my interest.

When the moment came I had to choose a subject for this thesis, the choice was easily made. Fairtrade production and economic growth are two subjects that really interest me, and I wanted to see whether there would be a link between them. In order to investigate this relationship between those, the following division is made: The first chapter will elaborate on what the Fairtrade movement is and where it stands for. The second chapter investigates whether the Fairtrade principles will have an impact on economic growth. Here, economic growth models will be applied. In combination with literature on economic growth the principles will be assessed. Third, the Fairtrade product with the largest history – coffee- will be studied to see whether the predictions made in the second chapter become true. In addition, it will be investigated what possible menaces there can be for the effect of Fairtrade production. Finally, the fourth chapter will be lead to conclusions stating that the overall impact on economic growth will highly depend on the (initial) market conditions the Fairtrade product faces.

Curiosity led me to write this thesis. It was a great pleasure to do the research. Every time I read something, I got more questions than could be answered. Lots more can be said about the Fairtrade movements and its effects on economic developemtn. One thing, however, that became clear, is perfectly expressed by J.S. Mill:

―No great improvements in the lot of mankind are possible, until a great change takes place in the fundamental constitution of their modes of thought.‖—J. S. Mill

Tilburg, June 2010

Eefje de Gelder

Chapter 1: The Fairtrade movement

This part will give a short insight in the history of the Fairtrade movement. In addition, their working methods and objectives will be discussed in order to get more insight in their goals and work process. Furthermore, the link between Fairtrade and economic growth will be given.

1.1. Vision and Objectives

Fairtrade1 can be described as follows:

―Fair Trade is a trading partnership, based on dialogue, transparency and respect, that seeks greater equity in international trade. It contributes to sustainable development by offering better trading conditions to, and securing the rights of, marginalized producers and workers – especially in the South. Fair Trade Organizations, backed by consumers, are engaged actively in supporting producers, awareness raising and in campaigning for changes in the rules and practice of conventional international trade.‖ Fair Trade products are produced and traded in accordance with these principles – wherever possible verified by credible, independent assurance systems.‖ (World Fair Trade Organization (WFTO) & Fairtrade Labelling Organization (FLO), 2009, p. 4).

The movement is driven “more by the desire to make a practical difference to the lives of people where we can, than by a need to conceptualize generic solutions to the problems of trade and development. It‟s an approach that served us well in the past”. The approach is aimed at identifying the needs and opportunities that small-scale producers face when trading in the conventional world market. In addition, their “work is driven by informed consumer choices, and the desire of business to meet the expectations o their customers, both of which provide crucial support for wider campaigning to reform international trade rules and create a fairer economic system” (FLO, 2009, pp. 3,4). This vision is translated in giving certificates to producers producing according to norms and standards set by the FLO. They state their arguments as follows:

 Ensure that producers receive prices that cover their average costs of sustainable production;  Provide an additional Fairtrade Premium which can be invested in projects that enhance social, economic and environmental development;  Enable pre-financing for producers who require it;

1 Keep in mind that Fairtrade is not the same as Fair Trade. “Fairtrade” will refer to certified Fairtrade programs, while “Fair Trade” will refer to the principle of fair trade relationship in the market that Fairtrade programs seek to create (Bassett (2010), p. 1).

 Facilitate long-term trading partnerships and enable greater producer control over the trading process;  Set clear minimum and progressive criteria to ensure that the conditions of production and trade of all Fairtrade certified products are socially, economically fair and environmentally responsible. (FLO, 2010) In order to get the higher price, the FLO sets price standards for each product. Next, for each Fairtrade product the buyer buys, he will have to pay a premium, which will be put in a common fund that the farmers can use for investment in production material, education, and health care. Pre-finance is needed in order to avoid high debts, while the long-term partnerships will guarantee the producer a certain quantity of products sold. Finally, a producer gets certificated if it accomplishes the standards set for hired labor and environment issues. By implementing and aiming at those goals and trade requirements, the Fairtrade movement aims at making the way in which trade is performed fairer and increase the well- being of the individual small-scale farmer.

1.2. History

In 1988, the first Fairtrade Labelling initiative, called Max Havelaar, started selling Mexican coffee with a Fairtrade label into Dutch supermarkets. This organization set up the production of coffee fulfilling various requirements set by Max Havelaar, because of coffee farmers arguing that “aid is nice to receive, but a fair price for our coffee is better. Thus we do not have to hold up our hands for aid anymore”. With a fairer price for their coffee beans, small farmers could become independent. (www.maxhavelaar.nl)

Due to the great success in the Netherlands several replicating initiatives were started in the late 1980s and 1990s throughout Europe and North America. These initiatives were unified under the name „Fairtrade Labelling Organization‟ in 1997 which nowadays acts as an umbrella for various Fairtrade marks. The goal of this unification was to harmonize worldwide standards and certification for the official Fairtrade mark, which can e seen on the cover of this thesis.

Currently, the organization has set up a separate organization for monitoring the accomplishment of the standards; certification of producer organizations and audit traders, called FLO-CERT. FLO now concentrates on setting Fairtrade standards and provides producer support. 2

The Fairtrade movement is concentrated in four organizations: FLO, World Fair Trade Organization (WTFO), Network of European World Shops (NEWS), and European Fair Trade Association (EFTA) 3. Next, nineteen labeling organizations hold license companies to use the Fairtrade mark in their country (2010, www.fairtrade.net). Part 1.3 makes clear how these companies function in the market.

1.3. Visual representation of trade process

Source: FLO Explanatory Document (2010), p. 11

2 The FLO is nowadays also member of the International Social and Environmental Accreditations and Labelling Alliance (ISEAL), an organization aiming at “creating a world where ecological sustainability and social justice are the normal conditions of business”. This organization is an umbrella for different labeling organizations, that is to say: not only for Fairtrade production, but also for example organic products. (ISEAL, 2010). Discussing this organization would go beyond the goal of this research, and therefore not be taken into account in the further discussion. 3 In the Appendix a more detailed description of these organizations is given.

1.4. Fairtrade and economic growth

Economic growth is associated with higher GDP, which basically consists of the consumption, savings, expenditures of government, and the net import results (Mankiw, 2003). Economic growth implies that incomes earned are increasing since one of the factors mentioned is increasing. Generally, economic performance in terms of economic growth is related with well-being of the inhabitants of the country. It is debatable to which degree growth will really improve the livelihood of the poor (see i.e. Dollar and Kraay, 2002), but that is another questioned not addressed here.

As may have become clear in the former parts, the Fairtrade movement does not primarily aim at increasing economic growth. Rather, they focus on the situation of the producer and on the way they are treated. The system where the Fairtrade movement trades in, is, however, the market where they are fighting at. This market has several structures determining the development of supply and demand. If the Fairtrade movement is booming, this will clearly affect the structure of the market and output of the economy. Hence, it makes sense to evaluate the Fairtrade principles according to their performance in terms of economic growth. If there is an overall increase in GDP due to e.g. a rise in productivity which is due to a Fairtrade program then the market which is affected may create spillovers for the whole economy. However, this will depend on the strength of the principles and working methods implemented, which will become clear in the following sections.

Chapter 2: Fairtrade principles and research on economic growth – a theoretical assessment

In order to assess the impact of the Fairtrade principles on economic growth, in this section the principles will be assessed with help of literature on economic growth. In addition, findings in research on the relationship between economic growth and different factors (causing that economic growth) are presented. Five different objectives4 of the Fairtrade movement are identified and assessed. In the end, general comments on the Fairtrade principles are given. - Fairtrade prices - Fairtrade premium - Provision of finance - Empowerment of producers and workers - Sustainable development

2.1. Fairtrade price

The Fairtrade movement promises a price guaranteeing that it covers at least the costs of sustainable production, even when the world market price falls5. In case the world market price is higher than the Fairtrade price, the buyer will have to pay the world market price. Several results with respect to economic growth are the result.

First, the Fairtrade producer is certain of a stable income that covers at least the production costs. With this securitization of income, the producer has more certainty for future production and will have higher incentives to invest in the production process. Supposing that the Fairtrade price will result in higher overall incentives to invest, the investments done by the agricultural sector may go up. Economic growth may be the result.

Second, the Fairtrade price is supposed to be higher than the current conventional price in the market. Ceteris paribus the higher price will lead to extra profits for the producer than they would have had without the Fairtrade price. This extra income can partly be used to increase consumption, but also a

4 These five objectives are a combination of the goals and benefits the Fairtrade movement state on their website (www.fairtrade.net). These five ones I identified as being the most important. 5 This holds for „most certified Fairtrade products‟.

8 part may be used for investment in production enhancement. An increase in investments may be the result. Next, part of the extra income earned may be saved, giving an extra boost to economic growth as will become clear below.

In Solow‟s model for economic growth, saving rates plays a key role in explaining a country‟s growth. First, each country has a so-called steady-state of capital, which is influenced by the investment rate and the rate at which it is depreciated. If the saving rate is low, the economy has a small capital stock and a low level of output. If saving rate is high, a large capital stock will be present. In addition, there will be a high level of output. Raising the saving rate will result in economic growth until the new steady state is reached6. (Mankiw, 2003)This relationship is shown in the following graphs:

Source: Mankiw (2003), p. 190,

6 Assumed that the economy starts with less capital than in the optimal steady state; hence low savings rates.

Source: Mankiw (2003), p. 199

Third, extra investment in capital may cause the labor productivity to go up, which is also increasing income, as can be shown in the following graph:

Source: Mankiw (2003, p. 209).

Empirics confirm the Solow model. One of the things the East Asian countries had in common when facing high growth7 was that they had high levels of capital investment, and a rapid growth of agricultural productivity (Stiglitz & Charlton, 2005). The following picture depicts the international evidence on investment rates and income per person. As can be seen, countries with high levels of investment tend to have higher income levels than countries with low investment levels:

Source: Mankiw (2003, p. 203) From: Robert Summers and Alan Heston (1991).

Although in the above picture clearly a relationship between investment and income can be identified, economists still struggle with causality problems. It may also be possible that a high level of income causes investments to go up. For Fairtrade, both explanations will result in an increase of economic growth. If income goes up due to the higher price, investment can go up and fostering economic growth. On the other hand, by increased investment (due to the stability Fairtrade prices create),

7 See appendix for the growth rates between 1960 and 2000

11 income in the longer-run may go up, thus resulting in higher economic growth. We should also be aware that different countries may have the same saving rate, but differ in their level of income. Hence, a high rate of investment will not guarantee that income (and hence GDP) will be high ( (Mankiw, 2003).

A fourth possible effect of the (higher than conventional) Fairtrade price concerns indebtedness. Research on indebtedness argues that the phenomenon „is cancerous, self-perpetuating, malignant, and maleficent‟. It abates agricultural production, abashes social psyche, aggravates inequalities in the distribution of socioeconomic opportunities and benefits, arrests social progress and misdirects social efforts‟. In the survey carried out in India, it was found that indebtedness will have a negative impact on the performance of the agricultural sector, hence decrease economic growth (Mitra, et al., 1986, p.1). By guaranteeing a price that covers (at least) the average costs of production, the producer will at least face a limited need for credit. It may be that the farmer will have to pay back his debts in the first period(s), but in the long-run, given the effects stated above, it may lead to a positive impact on economic growth.

Not only will a limited need for credit be the result; due to the stability the Fairtrade price guarantees the producer will face better possibilities to get a loan at a bank8. It is found that the most severe restriction in Ghana for small firms concerned the lack of access to finance, thus hampering economic development (Stiglitz & Charlton, 2005). Next, due to the decreased risk of the farmer price of the capital will go down. The combination of these factors will have a positive impact on economic growth.

Finally, stable prices also mean that production costs are covered in times the world market price for the product goes down9. This may imply that demand for the more expensive Fairtrade products decreases as well, since buyers will get products cheaper somewhere else. Less exports (since most of the Fairtrade products are exported) and lower economic growth will be the result. However, this will depend on the cross price elasticity between the certified and uncertified product variant. The higher the cross price elasticity, the more the products are considered to be substitutes, and the easier the buyer will change his consumption. Although often exact (cross) price elasticity is not known, if Fairtrade products are gaining market share and hence show that consumers are increasingly shifting their preferences towards more „ethically‟ produced goods, then a higher price will not have a severe impact on the demand. Research seems to confirm this. The following graph shows the willingness of the consumer to pay more for various ethically produced goods in various countries:

8 Given that capital markets are (almost) perfect. 9 Due to the possible efficiency improvement, supply may go up causing world market prices further to fall. Hence, an extra effect of Fairtrade products may be a widened gap between world market price and the Fairtrade price.

Source: Galarraga and Markandya (2004), pp. 120

2.2. Fairtrade Premium

On top of the agreed Fairtrade price, a premium is paid to the producers which they can use to invest in projects improving the quality of their lives. The members of the association decide democratically how to use the premium received. Typically, the farmers invest in educational projects and healthcare, farm improvements or processing facilities. This additional premium is paid by the buyers of the certified products.

First, the premium is normally a part of the price. Therefore, as could be seen in the section before, buyers may shift to conventional goods due to the price difference. Hence, it may have a negative effect on the economic growth. Again, this will depend on the price elasticity. Since there is an increased part of the consumers concerned about how products are produced, the effects may turn out to be marginal.

Second, the premium will be put in a common fund, which will be used to finance specific projects. I would like to evaluate the projects mentioned:

a. Educational projects The premium may be used to finance educational projects. A higher skilled labor force may increase economic growth, since the productivity of the labor force may go up. Research done throughout the years shows that secondary education is positively correlated with growth, as is primary schooling10. This is also confirmed in other literature: education can be seen as an investment in fixed capital11 (Steven & Martin, 2003). Below, two figures are provided indicating a relationship between the enrollment rate to primary school in 1882 and the GDP in 1913 (Maddison, 1991 cited in Stevens & Weale, 2003):

10 In a research covering 92 countries. 11 For this investment, extra money is needed in the form of extra income (the Fairtrade premium in this case).

In the research, a formula is calculated stating that a 1% increase in education will result in a 0.35% increase in economic performance. In the following table returns on education can be found, showing the relationship between education and income level identified by Psacharopoulos (1994) (Steven & Martin, 2003, p. 6):

Next, also other models and investigations show that educational attainment will lead to higher output. However, it remains unclear whether the effect comes from the level of education or from the extra education offered. In addition, the effect on economic growth will depend on the initial state of output and educational level, since diminishing returns to education play a big role (Steven & Martin, 2003)

In reality, a good example showing high(er) educational levels may have a considerable effect on the economic development of the economy is the „Asian miracle‟. In the East Asian countries not only high savings rates were important, but also great strides in public education were made. The combination of the increasing level of education and the high investment spending is estimated to take a huge part in the rapid economic growth (Krugman & Obstfeld, 2006).

Although the causality of education and economic growth is debatable, Fairtrade will lead to a higher output of the economy if the effects are large enough. Higher prices will lead to more income, which may increase the level of education. On the other hand: an educational project may lead to an increase in income. Hence, the Fairtrade premium investing in an educational project will have a positive effect on economic growth.

Finally, the poorest people in developing countries often show a low enrollment in primary school, which may be an indicator of the extent to which the poor participate in the benefits of economic growth. It can thus be questioned can be questioned whether a higher income does lead to higher education or vice versa (Dollar & Kraay, 2002). Fairtrade, aiming at the small-producers, may be offering a good opportunity for farmers to get education.

b. Health care

„ A greater share of social spending in public spending on health care is associated with better outcomes for the poor, depending on the extent to which public spending on health is effective and well- targeted towards the poor‟. Next to this statement, it is found that the share of spending devoted to health does not turn out to be significant (Dollar and Kraay, 2002). However, this finding concentrates on public spending by the government mainly benefiting the middle class and the rich, as can be shown in the following picture:

Source: World Bank Development Report (2004); pp.4

Since policymakers cannot provide health care services benefiting the poor government has to “look to other means (…). One way is to choose providers who have an intrinsic motivation to serve the poor. A study of faith-based health care providers in Uganda estimates that they work for 28% less than government and private for-profit staff, and yet provide a significantly higher quality of care than the public sector.” (Worldbank, 2004). If we apply this finding to Fairtrade premium investment in health care and consider it as a type of faith, then we may expect it to provide better quality and more efficient. The outcome for the poor farmers will therefore be positive. Having a better health condition and having better medical care will lead to less illnesses of the farmers and higher productivity.

Fairtrade premium will add an extra dimension to the health care services provided by the government, which turns out to be ineffective with respect to pro-poor growth. Therefore, as long as the health care investment will be effective the effect on economic growth may be positive, especially in the long-run.

c. Farm improvements and other process facilitation investments

Farm improvements may have a positive impact on investments and production efficiency. By improving the farm conditions, a higher output may be realized, as is the case for investments in process facilitations. Those investments will have a positive impact on economic growth.

2.3. Empowerment producers and workers

Small farmer groups must have a democratic structure and transparent administration in order to be certified. Workers must be allowed to have representatives on a committee that decides on the use of the Fairtrade Premium. Both groups are supported by FLO to develop their capacity in this area. In addition, the Fairtrade movement aims at better conditions for workers.

a. Democracy and transparency within organization

The Fairtrade associations can lead to more democracy in a country if the effects are large enough. However there are no significant differences in average economic growth rates are found between democracies and nondemocratic countries. The difference lies in the variance of economic growth: democratic countries tend to face less variance than nondemocratic countries. Increased democracy leading to overall democracy will therefore not lead to more economic growth. Nevertheless it increases stability of the growth rate and economic performance (Rodrik, 2000).

. A transparent administration is a very strong statement in the sense that it will be a good measurement to fight corruption within organizations (thus preventing it from functioning). Corruption is one of the biggest problems of developing countries. There is a strong relationship between the per capita GDP of a country and the rate of corruption (Krugman & Obstfeld, 2006), as can be seen in the figure below:

Source: Krugman and Obstfield (2006), p. 608 from: Transparency International & Worldbank

Making it compulsory to have a proper administration within the organization, may be a step forward to less corruption and higher output in the long run.

b. Contracts and partnerships

Through contracts, small-scale and traders of Fairtrade products agree on the terms of trade; beforehand, price, quantity and quality are determined. In addition, the buyers cannot force the producers to agree on unfavorable conditions (FLO, 2010). This increases the certainty for the producers. Through those contracts, long-term partnerships are to be created, hence increasing long-term certainty for the producers. While without Fairtrade they were delivered to the mercy of the market, now the producers are guaranteed a certain quantity that will be sold for sure. As discussed before, this certainty may have a positive impact on economic growth.

c. Hired labor and working conditions

First of all, it should be mentioned that the Fairtrade movement accomplishes the standards set by the International Labor Organizations (ILO)12. The additional benefits the Fairtrade movement adds on those standards focus on stimulation of organization, improvements in health and safety conditions, stimulation of improvement of disadvantaged groups, and child labor. The effect on economic growth is explained below.

- Organization of producers and workers is actively encouraged;

This organization of producers and workers is necessary in order to be able to receive a Fairtrade price. One needs to be member of a producers association in order to get Fairtrade certification. In addition, the Fairtrade premium aims at the cooperation of the producers, and the division of the extra premium. Cooperation between producers and workers is one of the main pillars underlying the Fairtrade movement. The more producers and workers will be associated, the bigger the impact of the organization will be.

- Workers are supported in actively improving health and safety conditions;

Improved health and safety conditions will be the base of a better human capital, which will have its impact on long(er)-term economic growth, i.e. higher productivity may go up causing output to go up as was stated earlier.

- Actively stimulation to improve of women’s positions and other disadvantaged groups with respect to payments and leadership13;

Women participation and its effect on economic development have been investigated deeply by Tansel (2001). He argues in a study carried out in Turkey that the participation of women in developing countries is declining, while it can contribute to more efficiency and equity. However, women participation differs per region and therefore the effect on economic growth rate will also differ. In addition, female education and economic development appear to have a strong positive relationship with the women participation. By improving the participation of women, their economic performance goes up, thus having a positive impact on economic growth.

- Any involvement of children in the labor process must be disclosed and monitored, and must not adversely affect the child’s well-being, security, educational opportunities and need for play.

12 The ILO is an organization under supervision of the United Nations and defends labor rights all over the world. See www.ilo.org . 13 Since it in general involves women, I will focus here on the position of women

Children in labor force working, is a complicated issue, since the different interests play a role. First of all, the main problem lies in the fact that parents prefer their children being at work, since they contribute to the family income. The benefits of giving a child education should be at least equalizing the missed labor income due to that education. In addition to that, children must be promising that they will contribute to their parents‟ income once they are working in order to compensate them. However, this will only hold for one generation (Hazan and Berdugo, 2005). As we have seen in the part about education, income and education are highly correlated, but the combination of Fairtrade principles overcomes this problem. If income is higher than the opportunity costs of working and the compensation costs for the parents, then this will have a positive impact on economic growth. However, if those are lower, economic growth will be affected negatively. Since, however, this will only be one generation, the long(er)-run on economic growth will be positive.

Second, if child labor is prohibited, the firm‟s profits may go down since children are employed cheaper than adults. (Basu and Van, 1998, cited in Hazan and Berdug, 2005). This effect may be compensated by the higher prices Fairtrade offers, but then the extra benefits the higher prices would generate are offset (and hence the Fairtrade price would not make any improvement for the farmer). Only the problem between the generations will play a role in that case.

2.4. Provision of finance

The Fairtrade contract with the buyer of the Fairtrade products requires them to give 60% of the agreed contract in advance (FLO, 2010) if the producers ask for. This may increase the possibilities to invest, thus creating favorable conditions for economic growth and development.14 Investigation of the World Banks observes that the most severe restriction small firms in Ghana faced after trade reforms in 1983 was the lack of or only limited access to capital for financing new investments (Stiglitz & Charlton, 2005) If producers are not able to get credits due to lacking financial systems or impossible high interest rates they will not able to invest thus causing the investment rates to be low and restricting other sectors in the economy to earn decent profits (Krugman & Obstfeld, 2006)

The provision of the credit should be equal or preferably lower than the current price of borrowing and thus be advantageous for the producer (FLO, 2010). Hence, giving the small-scale

14 An example of this may be: a farmer is able to buy a specific farming tool which is used for the land, and which may increase the productivity of the farmer as well as the quality of the output.

21 producers more access to finance may have a positive impact on economic growth given the condition that interest rates are lower than normal terms for credit.

2.5. Sustainable development

This part is aiming at the environmental part of the Fairtrade movement.15 Sustainable environmental development is pursued, which mainly entails requirements for „environmentally sound agricultural practices‟. On the Fairtrade website, the focus areas are stated as follows:

- Minimized and safe use of agrochemicals; - Proper and safe management of waste; - Maintenance of soil fertility and water resource; - No use of genetically modified organisms; - Organic production is not necessary in order to be Fairtrade certified, but is stimulated by rewarding farmers that produce organically by higher Fairtrade Minimum prices.

These restrictions on production can have several effects. On the one hand, it may cause inefficiencies due to the fact that producers may not be able to produce as efficient due to one or more of the constraints and thus hindering economic development.

Next, organic production may imply that the production process becomes more labor-intense and labor costs will increase. However, this will depend on the type of product and the degree of labor- intensity.

Concerning the market for products produced according to ethical standards, if people increasingly concern about energy resources, naturally produced goods, and genetically modified production, demand in the future may go up. If this is the case, extra certainty for the producer will be provided that he will be able to sell his products. As with the higher price and extra premium, this will depend on price elasticity of demand and consumer preferences for the good.

2.6. General comments on the principles and working methods of Fairtrade

In considering the different principles, the movement as a whole and its aims should not be mitigated.

15 On their website, sustainable development also entails the social conditions. However, I have treated this as an apart section since I considered it to be too important.

First, in order to succeed its goals, market conditions of a country should be in favor of economic growth (Raynolds, 2004). A country in which social unrest, war, or other disrupting factors play a major role does not provide a favorable scene for overall economic growth. A country should have relative stability in order to be able to face economic growth. Social, economic and political stability are essential, especially in the regard of property rights (Krugman and Obstfeld, 2006). The Fairtrade movement in itself is focusing on the small-scale producers, but not on the economy or country as a whole. Since the Fairtrade production is highly depending on these conditions, the development of Fairtrade production will be contributing only little on economic growth. Often, the success of Fairtrade will come along with other factors having an impact on economic growth. Fairtrade in itself creating economic growth will be depending on the size of the movement, as well as economic conditions.

Another factor, which has to do with the former, is that the Fairtrade movement act in a strange paradox. On the one hand, it is aimed making a change in the trade system, while on the other hand they want to participate in it (Bassett, 2010). This implies that if there is a lot of supply while demand is low, the consumers still have to pay a lot for the good because the small-scale producer needs to be paid for his costs. Oversupply will be the result, and hence economic inefficiencies will be the result. To make this change possible, the whole trade system (which means: consumers) have to change their way of thinking, which is not easy16. Moreover, if this will happen, economic growth may be hampered due to the problems stated above .

Suppose now that supply mainly determines demand instead of the other way round. Then, they work through the conventional system by making the consumers aware of the existence of the Fairtrade product and underwhelm aiming at changing the same system. In that case, the product-variety model developed applies. This theory developed by Romer states that productivity will grow by „new, but not necessarily improved, varieties of products‟. If we consider a Fairtrade product as an improved variety of the conventional products, Fairtrade will lead to economic growth. More product variety raises the economy‟s production potential because it allows a given capital stock to be spread over a larger number of uses, each of which exhibits diminishing returns. New varieties, new innovations themselves result from R&D investments from people that are motivated by the prospect of monopoly rents if they successfully innovate (Acemoglu, 2009). In that case, Fairtrade products may be a variety causing economic growth to go up17.

16 Remember the citation of J.S. Mill at the beginning of this thesis, which perfectly fits behind this idea. 17 There can be said a lot more on the principle of Fairtrade being “in and against the market”, but since this thesis focuses on economic growth, only those effects are mentioned.

2.7. Conclusions on theoretical research and Fairtrade production:

As will have become clear in the above section, the overall effect of Fairtrade principles on economic growth will be positive. Although sometimes causality is not clear, the combination of principles makes that positively related factors may enforce each other.

The predicted effects are under the condition that the Fairtrade movement will be able to make real improvements in the living conditions of the small-scale producers. The effects need to be widespread among all small-scale producers, or at least there should be spillovers to other sectors of the economy in order to be able to have an impact on economic growth. In addition, taking the vision of Fairtrade as a whole, it may create inefficiencies. This, however, depend on the specific market conditions, wherein consumer preferences are very important.

Section 3: Empirical research – Fairtrade coffee

In this section the effects of the Fairtrade principles on economic growth in practice will be investigated. The objective is to get knowledge on how Fairtrade works in practice, and whether the predicted outcomes of the former section can be observed in real world. First, the coffee market will be analyzed, which I chose because it has the longest history and therefore provides the most information on possible developments. Second, I will give some overall effects that are the result of the whole Fairtrade movement. Third, an overall conclusion will be provided.

3.1. Market

Around 70% of the total coffee production depends on small-scale farmers from which most of them live in poverty. A crisis in this market will affect their living conditions substantially. During the most recent coffee crisis (2000-2004), coffee prices declined sharply (Bacon, et al., 2005). Since 2004 the market for coffee has been recuperating and prices have been rising since then (Food and Agricultural Organization (FAO), 2009) which can be observed in the following graph:

Source: ICO cited in FAO (2009), p. 6

Next, a table with the market shares of Fairtrade coffee is provided to show the market shares of Fairtrade coffee.

Source: different sources, cited from FAO (2009), p. 13

3.2. Fairtrade price

The higher Fairtrade coffee prices during the latest crisis were clearly acting as a safety net for coffee producers in developing countries such as Uganda, Mexico and Nicaragua. Small-scale farmers were four times less likely to lose their land to credit lenders. Also, the probability of being forced to sell the land was four times less than the conventional producers (Bacon, et al., (2008) cited in Wilson, 2010, p. 85). This prevented them from going bankrupt and having the economic consequences of that on the economic growth of the country. The following table demonstrates how the Fairtrade price and world market price developed together over time:

Source: Valkila & Nygren (2008), p. 8

The graph on the following page shows the Fairtrade price with respect the conventional price for Arabica coffee. Besides the price development, also important market conditions that made the price of coffee low or high, such as droughts in Brazil can be seen.

Source: Fairtrade Foundation in: FAO (2009), pp. 12

Since prices have been going up since 2004, little difference can be observed between conventional and Fairtrade prices. Where Fairtrade producers got a price of 87.9 US cents/lb , conventional prices were around 88.9US cents/lb18. It can be argued that conventional farming would be more advantageous, given that producers would sell their coffee at moments the conventional price was at its highest (Valika, 2008). Hence, when world market prices are paid for Fairtrade products, the Fairtrade price does not make any difference in effect on the income of the farmer and make no difference in effect on economic growth. In that case, the other benefits of Fairtrade must have a substantial influence on the economic development in order to be growth enhancing.

Bacon (2005, pp. 506) concluded from his survey among coffee producers in Nicaragua that higher coffee prices are not sufficient to increase livelihood conditions. Although prices had gone up for Fairtrade producers, still 74% of the farmers mentioned a decrease in their well-being. A small-scale farmer stated “well-being is to have health, food, education and tranquility in the family”. Fairtrade did not make any difference in comparison with conventional trade. As higher level of well-being can increase economic growth through higher productivity, apparently this effect is not necessarily true.

Next, the Fairtrade price is not only pressed by rising production costs; Fairtrade producers face extra costs for the high transaction costs of processing and marketing the high quality coffee demanded in the Fairtrade market. Also, the cooperative structure and certification process both contribute to the higher production costs. Hence, although higher prices are offered, prices offset the possible effect on economic growth due to lower income, reduced competitiveness, and insolvency (Wilson, 2010).

With respect to prices on the demand site, price elasticity turns out to be lower for Fairtrade produced coffee. Consumers in Belgium buying ethically produced coffee, were willing to pay a 10% premium (Pelsmacker, et al. (2005), cited in Arnot, et al., 20006, p.3), and American consumers a $0.22 over a price of $0.60 per pound of Fairtrade coffee, while those premiums for conventional prices were lower (Loureiro & Lotade (2005) cited in Arnot, et al., 2006, p.3). Rising price may be even turn out to be profitable since i.e. Canada faces “low cross-price elasticities for Colombian and other coffees as the price of fair trade increases”. In addition, “the proportion of purchasers “abandoning” the Fairtrade product would be low if price increased,” (Arnot, et al., 2006, p. 6).

The survey showed that producers could even increase profits if they allowed the price to go up further (Arnot et al., 2006). This shows that the more ethically consumers there will be, the lower the effect will be in case of a price increase, and the less the effect on the supply.

18 With variation in the coffee price from 75.5 to 99.5 US cents/lb

3.3. Fairtrade Premium

The Fairtrade association in the coffee production of Nicaragua attracts projects of international NGOs in order to improve the well-being of the farmers, such as projects to increase literacy, decrease child mortality, improve access to drinking water, and so on. These investments are also sponsored by international NGOs, whose donations would have been lacking otherwise (Wilson, 2010).

Next, Raynolds states that members of cooperatives in Latin America “are increasing investments in education: purchasing additional school supplies, allowing their children to remain in school during the coffee harvest and even supporting additional years of schooling. Members (…) point to important investments in women‟s non-farm income generating activities. These long term investments reflect producers‟ growing confidence in the future.” (Raynolds, 2004, p. 1118).

On the other hand, it is argued that the projects initiated by Fairtrade often go hand in hand with normal producers and the necessity for Fairtrade cooperation can be asked (Valkila & Nyrgen, 2008).

Considering that there is hardly evidence available on the projects, the above literature makes the impact on economic growth ambiguous and region-depending.

3.4. Empowerment of producers and workers

As the Fairtrade movement is aiming at helping the poorest, marginalized producers, in Nicaragua the coffee farmers are a “heterogeneous group socio-economically. There are wide variations in wealth, levels of education and sources of livelihood.(…)” (Valkila, 2009, p. 3023). Another study done in Nicaragua: “Those who owned larger properties stood out from the rest in terms of their access to ample credit, their investment in yield improvement, and their power within the cooperatives. These farmers represented a different class of participants in the Fairtrade cooperative”19 (Valkila, 2009, p. 3023). Therefore, it is important to consider the viability of Fairtrade organic coffee production for low- intensity and higher intensity farms”. Hence, the impact of Fairtrade and resulting outcome will be varying to the initial well-being of the producer.

Next, it turns out to be that the standards on labor rights are not very strict in the case of seasonally hired coffee production. This is a difficult thing accomplish, since farmers lack information on

19 Nevertheless, those –few- producers also faced the same problem with respect to get credit (The context where I am citing from).

30 the advantages provided by Fairtrade certification. In addition, the advantages depend on the prices in the market and production intensity of the farmer. (Valkila, 2009)

With respect to producers‟ cooperatives, in Latin America cooperatives have only few years of schooling, most of them only speak Spanish, and have little knowledge about the functioning of international market. This makes it difficult to form strong democratic structures. Therefore, “success in Fairtrade necessitates managing the inherent tension between cooperatives, democratic commitments and the organizational requirements of world markets,” (Raynolds, 2004, p. 1116).

3.5. Provision of finance

Fairtrade coffee producers sometimes have to wait longer for their money than conventional producers, as can be seen in figure 3 below. Instead of providing farmers better with finance than conventional producers, they had to wait longer. Certified coffee was therefore sold in the conventional market instead of the Fairtrade market, which clearly affects the impact of the Fairtrade movement.

Source: Bacon ( 2005), pp. 505

3.6. Sustainable growth

In Nicaragua, an organic farm produces one-third less than a conventional farm. In addition, the organic production was more labor-intense. Valkila (2009) finally argues that “Fairtrade organic coffee production therefore does not provide advantages to hired labor beyond those offered by agricultural labor in Nicaragua in general”. (p. 3023)

On the other hand, farmers do want to produce organically due to stable market prices in comparison with prices in the mainstream market (Valkila, 2008). In addition to that, Raynolds (2004, p. 1117) argues that “Fair Trade environmental specifications and the encouragement of organic farming have health benefits for communities and ecological benefits that extend even further. Since improving coffee quality and gaining organic certification requires significantly increasing the amount of labor devoted to coffee production, employment opportunities are enhanced for community members needing paid work.” No concrete data is available on this evidence. Hence, the findings on this are mixed and require deeper investigation.

3.7. Conclusions on Fairtrade coffee impacting economic growth

In practice, the Fairtrade principles are hard to impose. The specific market conditions and country situation determines the Fairtrade principles being ineffective in reaching its goal. When world market price for coffee is high, it would be more profitable to sell the Fairtrade certified coffee in the conventional market. Although higher stability was created –and farmers liked that- , Fairtrade does not necessarily make a difference with conventional practices and hence will not foster economic growth.

Next, rising costs put higher pressure on the farmers, and also their indebtedness remains a problem. Most premiums are directly paid to outstanding debts. Due to those factors the benefits of higher Fairtrade prices are deprived and cannot be used for extra consumption to raise consumption.

Fairtrade coffee sales are increasing (Raynolds, 2004), indicating that consumers do increasingly care about it. Future development of this market may hence be profitable. Due to these price elasticities, it was even shown that sometimes it may be profitable to increase price

Chapter 4: Conclusions

All Fairtrade principles seem – or are able to – foster economic growth in a sense. The higher and more stable Fairtrade prices will increase the (certainty of) profits the small-scale producers will obtain. Additional benefits can be used to invest in efficiency enhancing producing methods. This also holds for the Fairtrade premium aiming at developing projects such as health care, education and better production methods. Small-scale producers deciding on how the premium will be spend, will increase the probability that the project is well-targeted, thus increasing the probability of having an impact on the economic development. Cooperation may have as an effect in the long-run that democracy is enforced, although this will not have a significant impact on economic growth in itself but only on the variance of economic growth. Finally, the focus of the Fairtrade movement on sustainable economic growth may lead to a better and more sustained use of resources, hence increase efficiency and productivity.

However, the Fairtrade movement should be also assessed in the whole market situation it is in, since the overall impact of Fairtrade will primarily depend on this. First, there should be a stable political environment in order to guarantee certainty. Second, (a part of the) consumers will have to be eager to pay a higher price for the Fairtrade products. Hence, if consumer preferences are shifting towards the conventional coffee, the possible future market gains will disappear. In addition, market shares should go up for having real effects, something that is realized within the movement. That increased market share will give more insight in the effects of the movement, since then the trade system will have to change, i.e. if consumers increasingly want to have their goods produced in a certain way, in the end there is no choice than to adapt to that changed preference. This will help the Fairtrade movement to come out of the paradox “in and against the market”.

Currently, the Fairtrade movement creates ambiguous effects on the economic growth of a country which could be seen in the development within the coffee sector. On the one hand, the prices acted as a safety net in times of crisis, thus having positive impacts on economic development, while if world market prices were higher, that benefits were offset. In addition, production costs might be higher due to the standards set, leading to less inefficiency. Also, ambiguous effects are observed with respect to labor conditions and other sustainability enhancing production methods.

Considering the past results, I would argue that the Fairtrade movement will have to go a difficult path in order to increase economic growth. Their approach needs to have a higher influence in the market, which should be created by increased sales. Consumer preferences are already shifting into a beneficial direction with respect to that.

Next, based on the research carried out, I would argue that the Fairtrade movement in itself will cause little or no economic growth, but is fostering economic growth due to the subjectivity of country- specific conditions on the market with respect to stability and productivity. However, due to a lack of reliable data on the real impacts in the long-term, future research will have to show whether this is true. In addition, the market studied here is only one of the markets the Fairtrade movement is active in. Hence, the results might be biased. Another factor not considered here, was the quality of the Fairtrade production. Consumers might be more willing to buy high-quality coffee, resulting in even lower price elasticity. Those effects need more research.

Appendix Output per Capita in Selected Countries, 1960-2000 (in 1996 US dollars)

Source: Krugman and Obstfeld (2006), p. 605 (obtained from the Penn World Table version 6.1)

Partners of the Fairtrade Labelling Organization – description

World Fair Trade Organization

The World Fair Trade Organization (WFTO) was created in 1989. It was originaly known as the International Fair Trade Association. It is a network of alternative trade and producer organizations in Africa, Asia, Europe, Latin America, North America and the Pacific Rim. WFTO's mission is to improve the livelihoods and well being of disadvantaged handicrafts and agricultural producers. WFTO links and promotes Fair Trade in both developed and developing countries.

Network of European World Shops

World shops sell Fair Trade products and organize various educational exhibits, programmes and campaigns to promote fairer trade practices.

The Network of European World Shops (NEWS!) was established in 1994. It is a network of national associations of world shops representing 2,500 shops in 13 member countries: Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Netherlands, Spain, Sweden, Switzerland, United Kingdom.

NEWS! initiates and coordinates European-wide joint campaigns and awareness raising activities. The aim of NEWS! is to promote Fair Trade and the development of the world shops movement in particular.

European Fair Trade Association

Fair Trade importing organizations buy food and handicrafts from disadvantaged producers in developing countries. They aim to improve market access and strengthen the producer organizations.

The European Fair Trade Association (EFTA) was established in 1990. It is an association of 11 Fair Trade importers in nine European countries: Austria, Belgium, France, Germany, Netherlands, Spain, Switzerland and the United Kingdom. EFTA's aim is to support its member organizations in their work and encourage cooperation and coordination.

In Europe, EFTA members sell their products through world shops, local groups, wholesalers and mail order catalogues. Fair Trade importing organizations also play an important role in awareness raising and in educating consumers and public authorities on Fair Trade and trade justice issues.

Geographical scope of Fairtrade principles:

Source: FLO (2009)

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