Is Free Trade Fair Trade?

February 23, 2007

Expecting the world to treat you fairly because you are a good person is a little like expecting the bull not to attack you because you are a vegetarian.
Dennis Whole

We will assume, for sake of simplicity, that fair trade takes place between a undeveloped country (the seller) and a developed one (the buyer), but it is meritorious to mention that fair trade also applies for commerce within a country (like Mexicans from the city buying coffee from Mexicans from Chiapas).

According to Fair Trade USA, there are 20 fair trade certifiers worldwide working with over one million farmers. But recent studies by the World Bank conclude that the benefits of free trade and economic liberalization have failed to reach the world’s poorest people. Paul Rice notes that many of these “victims of globalization” are small farmers in the developing world. Fair trade is a market-based approach to solving global poverty, he explains, one that helps make free trade work for the poor[1].

Suggestions that “unfair’ products may be taxed or that imports have to comply with ILO[2] standards have led to criticism from free trade advocates and even fair trade promoters are cautious when demanding protectionism or international intervention. Fair trade is seen as paternalism in international commerce[3].

The emphasis is that is the lack of free trade what is affecting developing nations: Protectionism, quotas and agricultural subsidies from the developing world are affecting third and second world producers.

The idea of fair trade is paying a fair price for the product of the work of different farmers and workers. One of the global implications is that, in perfect market conditions, the price of a product would be fair since the producer will not be willing to sale at a lower price of a given amount. Free trade will equals fair trade (Brink Lindsey, Milton Friedman).

The problem is that there are some market imperfections:

· Several industrialized countries, like USA and France, have strong subsides to the agricultural industry[4]
· Industrialised countries are larger economies than non-industrialized[5]
·
The fluctuation of commodity prices doesn’t guarantee a living wage for many producers, forcing them into debt and poverty[6].
·
The fluctuation of the currency between first world countries and underdeveloped and developing ones often alters the price of the product in an unnatural way[7],[8]

In the 1980’s, the US government policy provided $260 billions to American Farmers[9]. In 2008, the final NAFTA protections to Mexican bean and corn will fall, leaving poor Mexican farmers alone against the most subsidized farmer economy in the world.[10]

These imperfections make very difficult for smaller traders to compete. The argument is that multinational companies are able to benefit from subsides and protections that small economies cannot provide. The economic situations that these imperfections bring may fire backwards to developed countries when illegal immigration and terrorism are exported along with the goods. Flora and fauna extinction, social unrest and deforestation are faced in producing countries as result of poor economic conditions, like Chiapas in Mexico.

Fair trade hence gives consumers to use their purchase power as a vote to balance the situation[11]; fair trade then tries to set a fair price for the product, on the basis that the price shall:

  • Covers the costs of production.
  • Allows the peasant or worker to actually make money.
  • Allows re-investment in the farm or factory and
  • Allows the peasant or worker to work on safe conditions.

So, how much is a fair trade product priced
over a non-denominational

[12]

one? Here some examples
:

Product Fair Trade Non-Denominational
Coffee 1.26 .063
Cashews 2.48 2.38
Chocolate 0.73 0.64
Tea 1.25 1.00

I haven’t find evidence on how the fair trade price
is set and I haven’t found evidence that the price stated complies with the
fair trade mandate. There is very little work on the extend of how lives are
changed by effects of fair trade[14] Hudson and Hudson document that the producers of the cooperative “Majomut” in Chiapas are getting $148 USD more per year in an entity where the average salary is $1,345 USD per year, but they cautious us of not taking one
single result as a general effect of fair trade.
The traditional test of fairness is the voluntary consent of each party to the business.It is “The free will that constitutes fair exchanges” 15] . When an estimate of the value of a third or second world
product is done in the first world, we are estimating the value of a foreign
market from a distorted perspective. The word fair is usually what a willing
buyer will pay a willing seller[16], but given the mentioned market imperfections, we need a measure to determine what would be a fair price for a given product.



[1] “Why Fair Trade?” Paul Rice, TransFair USA, video conference held on March 2006. Available on http://www.big-picture.tv
[2] International Labour Organization
[3] “The Myth of Fair Trade”, James Bovard, Cato Policy Analysis, Nov 1, 1991.
[4] The U.S. government spent $2 billion in 1986 to flood international markets with American rice, driving down the world rice price by 50 percent. The Thai rice program spent less than $100 for each Thai rice grower, while the U.S. program spent the equivalent of over $l million for each full-time American rice grower between 1985 and 1990. Thailand’s average per capita income is $860, while the average American full-time rice grower was a millionaire even before receiving lavish subsidies in the mid and late 1980s.
[5] “Why Fair Trade?” Paul Rice, TransFair USA, video conference held on March 2006. Available on http://www.big-picture.tv
[6] http://www.fairtrade.org.uk/about_what_is_fairtrade.htm, retrieved on April 2006.
[7] Washington lawyer David Palmeter observes: “In the U.S., exchange rates in anti-dumping proceedings are determined by applying an outdated regulation, a relic of an era that ended in the early 1970s when the fixed exchange rate system established at Bretton Woods was abandoned. . . . The rate established by the Federal Reserve is a quarterly one, set in advance, and based on transactions at the end of the previous quarter. . . . This average rate is used throughout the quarter unless, on any particular day, it varies from the average by more than five percent, in which case the daily rate is used.” N. David Palmeter, “Exchange Rates and Anti-dumping Determinations,” Journal of World Trade 22, no. 2 (1988): 73.
[8] The depreciation of the Brazilian real from 1.20 to the dollar in January 1999 to 3.60 as of January 2003 has caused Brazilian costs in dollar-denominated terms to fall markedly.
[9] “The Politics of Plun der”, Doug Bandow, New Brunswick, N.J.: Transaction Books, 1990.
[10] “Los Idus de Julio”, Carlos Fuentes, El Norte, Jul. 21, 2006.
[11] “Students Guide to Fair Trade”, Louisa Lyne, Oxfarm, 2006.
[12] The author resists to use the term ‘non fair trade’ since he’s trying to avoid the implication that products without the fair trade labeling are unfair.
[13] Retrieved from http://www.worldcentric.org/store/pricing.htm on July 2, 2006
[14] Hudson and Hudson, “Removing the Veil?”, Organization & Environment, Dec 2003, p 422
[15] John Taylor, 1822.
[16] U.S. Department of the Treasury, “Report of the Secretary of the Treasury to the Congress on the Operation and Effectiveness of the Anti-dumping Act and on Amendments to the Act Considered Desirable or Necessary,” 1957, pp. 1819.

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The Multiplier Effect and Fair Trade

February 12, 2007

Fools are not generous: the world of the gods is not for the stingy. Wise men are generous: they find happiness in the next life.
Dhammapada, pp. 98

A phenomenon exists in Economic Theory that has significant effects in everybody’s life, while only a few are aware of: The Multiplier Effect.

Let’s say that, in general, people in a country save 20% of their income and spend the rest. This 20% is called Marginal Propensity to Save (MPS). The opposite factor, the 80% that people spend is called Marginal Propensity to Consume (MPC). Since they are percentages, they always sum one: MPS+MPC=1.

Now, let’s say that a corn producer community with a MPS of 20% sells corn at $100 the metric ton. The corn is sold in the international markets, and when the producer receives $100, he’ll spend $80 in, let’s say new machinery. The guy who sold the machinery now has $80, so he saves 20% and spends $64 in furniture. The furniture seller now has $64, saves 20% and spend $51.20 in groceries. Successive rounds of spending will be $40.96, $32.76, $26.21 and so on. The initial spending of $100 triggers more spending in a ratio of 5:1. This is called the multiplier, and it’s calculated simply as 1/MPS. In this case, 1/.2=5, so the initial $100 injects the local economy a total of $500:

Corn Multiplier

Because the money came from international markets, the full $500 is reflected as an actual growth in the local economy.

Now let’s say that the Fair Trade price of corn is $120 instead of $100. Apparently the difference for the corn producer is only $20, but for the community is way more:

Corn Multiplier for Fair Trade

The local effect is $100, no $20, due to the multiplier

The 20% saving rate in a rural community is rather high. Rural communities in third world have very low savings rates, because they live in a day by day basis; thus, the multiplier effect is even higher, for a community with only 5% saving rate, the multiplier is 1/.05 = 20 times, so the extra $20 per metric ton translates in a $400 injection to the community.

THE PARADOX OF THRIFT

A key point that derives from the marginal propensity to consume is the paradox of thrift. If people start to save more money, the bank system will have more money to lend to the industry, thus investment will go up and there will be more good and services, and because people is saving more, their future is more secure. What really happen is that now people are spending less, so the demand curve for all goods and services shift to the right. As consumption decrease, so the economy; people start getting fired, companies have to decrease production, and the general income shrink. As income falls, so the savings. People were trying to save more, but they really ended up saving less.

This is why economies like USA’s promote overconsumption, so the economy never shrink. The people live over their limit because the way the economic sectors are integrated, spending more makes the economy grow.


Stakeholder Analysis

November 10, 2006

As you see yourself, see others as well; only then will you become a partner in heaven

Bhagat Kabir

When you are performing an economic transaction they are usually two players involved, the seller and you, the buyer. These two players are, though, not the only ones involved. You have the producer of the good or service you are buying, the organization it comes from, the bank that may be involved in the economic transfer, et cetera. A stakeholder analysis is a tool that uncovers all the entities involved in that transaction, and it is very useful to understand the chain value that is necessary for making the product or service available to you.

In my last post, I mentioned that Wal-Mart is dumb-folding at least three stakeholders in order to offer a lower price: The store employee that is being paid minimum wage and has no a full time position; the producer that is forced to serve Wal-Mart with lower-than-usual prices, to deliver directly to the racks and to keep inventory. It is also profiting in the low wages of the people who manufacture or produce the good; remember the Buy American campaign? Now Wal-Mart is the larger commercial partner of China. Competitors are other stakeholders hurt by Wal-Mart trawling tactics, often put to sleep after several months of mammoth operation by the super retailer.

A common stakeholder analysis includes, at least:

  • Producers
  • Retailers/transnationals/brokers
  • Consumers
  • Competitors
  • Government
  • Workers
  • Environment

A more deep analysis will also reveal:

  • NGOs and other community organizations
  • Schools
  • Community

These are the actors involved in every transaction you made. Think of them when buying the next product that may be gentle with your wallet but hurt the trees on the park where you children play.


The True Cost of Production

November 3, 2006

 

Designing your product for monetization first, and people second will probably leave you with neither.
Tara Hunt

Let’s go back to the supply’s graphic. We mention earlier that there is a minimum price that the producer will ask in order to start offering the article or service that will cover the costs and yield a profit and a maximum quantity the seller can offers due to installed capacity and other variants:

sdpic4.jpg

The start point here is how the seller calculates the minimum price. By seller I mean the industry as a whole and also a particular seller, this is just an example on how prices are set.

For any given product, you have two different costs: fixed and variable. The former is the cost that exists even if you don’t produce anything: rent, electricity, cost of equipment you need et cetera; the latter is the aggregate cost of producing an article or product: cost of seeds, raw material, variable labour, et cetera. Often these costs may blur, like management salary, or the cost of a marketing campaign, the important thing is that these are the common two divisions of cost that accountants and financial managers know well.

For producers, labour (including management wages) and raw materials are usually the main cost they use on calculations. When you go to Wal-Mart and buy a cheap product, you should know that the product is cheap because Wal-Mart has either a low cost on raw materials (lower quality materials) and also a lower cost on labour (part time employees that don’t receive benefits and work for minimum wage), so Wal-Mart is able to offer you a low cost at expenses of other stakeholders’ benefit.

Stakeholder is defined as an entity that is affected by a process. In any productive chain, usually you have as stakeholders: The Corporation, the government, the customer, the worker and the environment. I will next post a more deep analysis on stakeholders, but for now is important to know that all these entities are affected by any productive chain.

So, how is the price set then for a given product?

P= fixed cost + variable cost + possible profit

For retailers, like Wal-Mart:

P= Lowest possible fixed cost + lowest possible variable cost + maximum possible profit

For retailers like Ten Thousand Villages:

P= fair fixed cost + fair variable cost + fair profit

The last question should be then, what is a fair cost? Francisco Van Der Hoff, in the Congress of Humanity and Social Science at York University (Toronto) stated that the cost of producing any product is composed of three elements:

· True cost of production. This means not only the cost of the raw material, but also the land, salary of workers, and opportunity cost of growing a product instead of another.

· Social cost: The impact and repercussions for the worker and his or hers surroundings like education for children and hazardous working conditions.

· Environmental cost: The cost of soil degradation, fertilizer poured in the land and hazard to the ecosystem, et cetera.

So, next time, think twice before buying a cheap product that may be done at the expense on somebody else’s quality of life.